Public companies are not set up for innovation

Last Friday my colleague Cedric Latessa sent me the following email:

General Electric is the only company remaining from the Dow Jones index of 1896. It has had fewer leaders since then (eight) than the Vatican has had popes.
Fortune

At first I was tempted to post it for the amusement value alone, but over the weekend I got to thinking that there was more to it that that.  This GE story is remarkable because the average tenure for a large public company CEO is somewhere around three years, and three years is too short a period to think about innovation.

The average venture backed company is probably 1-2 years old when it takes it’s first VC investment and that investor will be planning on holding the investment for 3-5 years before exiting.  It is only at the exit point that the company has demonstrated enough success to be significant for its acquirer meaning that from inception of the idea to being really significant the time period is 4-7 years.  If the average tenure of a large company CEO is 3 years then it is easy to see why investment in speculative innovation isn’t top of her priority list.

There are also a host of other reasons why innovation is happening more and more in small companies, of which the increasing pace of change is probably the most important and the stock market focus on quarterly results springs to mind given the central theme of this post.

Companies like Cisco, Microsoft, and IBM have been outsourcing R&D to the startup and venture communities for a long time and more recently Google, Yahoo, and AOL have picked up on the habit.  Going forward I expect we will see more of this, not less.

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  • Why is their tenure so short, though?

  • Don't know if “outsourcing R&D” is fair and complete. MSFT and GOOG do a fair bit of in house innovation (surface computing, xbox at MSFT, Wave, Gmail, apps etc at Goog) as well as working with the start up community and VCs. Do say that one approach happens and the other doesn't isn't really the case.

  • I don’t think it’s just due to the short tenure of a CEO. Quarterly reports, incentive plans tied to EPS performance or stock price improvements, a disdain in the public markets for R&D expenditure. The nature of our public markets militates heavily against innovation.

    Ask an average board if they would like to see revenues and profits fall by 20% for three years while the company re-aligns itself to a new business model, or if they’d like to say three years of 20% growth as the company slashes R&D etc before it falls over a cliff. Most would, in practice, choose the latter.

    But twas ever thus – and hence I agree that R&D has been effectively outsourced to entrepreneurs and VCs.

  • Hi Nic,

    Excellent post. One wonders how well public companies are set up to integrate innovation, too. There seem to be so many examples (I’m thinking specific to the UK but applies across globe as well) of successful products that go off the boil after aquisition.

  • Long may it continue!

  • Thanks James. Post acquisition integration is a big issue, particularly in digital media.

  • True enough. It would have been more accurate to say 'partially outsource R&D'

  • Good question. I suspect because public company boards reach for their guns as soon as the share price comes under serious pressure, which it is almost bound to do every now and gain.

  • Hi Nic, I'm going to disagree and agree with you on this (how typical of me!)

    Agree- Large Corporates (by and large) DO NOT INNOVATE. They aquire smaller and more agile companies to do that for them. I know this first hand from experience as a Business Manager in a Fortune 16 company.

    Disagree- “Public Companies are not set up for Innovation”
    I'm going to presume by “Public” you mean publicly “Listed” companies and are not referring to the whole PLC portfolio of companies, the majority of which are not listed. If you are referring to publicly listed companies then I agree, if you are including all PLCs as an entity then I disagree. Furthermore, we then we have “AIM listed” companies, not “listed” in the sense of being on a regulated market, but close to it. Now if we look at many of the AIM listed companies I would say they are well set up for innovation. They've got access to capital (good for product development, good for founders and recruiting/retaining talent), they've got status and recognition (good for morale) and they haven't got the burden of a large public ownership base (retaining ownership and control) and haven't got all the usual restrictions associated with VC financing. In my view, an ideal platform for fostering innovation!

  • David,

    I've rarely heard good things about AIM (generally: “all the disadvantages of a public listing (reporting, transparency, short-termism) without the advantages (deep pools of capital, liquidity, kudos)”.

    Are your comments based on personal experience? If so that's great – I'd love to hear more.

    (And I'm sure Nic is only referring to publicly listed companies. From an entrepreneur's point of view, a plc and an ltd are just legal structures with no practical difference. It's only once the shares are listed on a recognised exchange that anything changes)

  • Hi David – we are in agreement! I was talking about large publicly listed companies – e.g. the FTSE 250.

    I share Nicholas's reservations about AIM as a home for small businesses though.

  • Hi Nicholas

    An AIM listing can bring enormous value to an emerging company (aside form capitalisation) if done well. And I stress, the term “done well”.

    Let me deal firstly with some of the “failings” or perceived failings of AIM.
    As it is not a registered listing, it's regulations are relatively light and its entry requirments are not restricitve- it enables and sometimes invites a pool of companies to float on AIM who would otherwise not be worthy of such a listing. I am thinking of the numerous investment companies, real estate investment companies, mining companies and media/entertainment companies that have no trading history and float on AIM. For the most part they do not raise significant capital, and unfortunately scew the data as well as draw criticism to AIM.

    Also, as AIM became so successful (both in volume and in liquidity) over the years the NOMADS, Brokers and Lawyers are inflated their fees to such a point that the cost of obtaining an AIM listing became almost prohibitive. This meant fewer and fewer emerging companies could afford the fees to list and relegated AIM to a small niche market for more established companies wishing to access a capital market or for companies who no longer could afford or meet the criteria for remaining on the Main market. In this sense AIM no longer served its purpose as a venue for fostering emerging companies.

    Now for the positives:
    On AIM you don't have a minimum threshold for public ownerhsip, you don't necessarily have to make a public offer either, you can obtain a placing instead. This saves on the cost of the Prosepctus and the legal fees. Your reporting requirements in my view are light. If you can't comply with AIMs reporting requirments then you really have no right to be holding any shareholders' capital imho. THis is not the same as a Main listing reporting requirements.

    Liquidity on AIM is pretty good, and ironically as the volume of new entrants has fallen to a minimum, the volume of capital traded on AIM has largely remained steady. Do the maths and you'll figure out what that means for companies on AIM.

    Furthermore, the market situation has now forced NOMADS, brokers and lawyers to look at charging more realtistic (not inflated) fees. Some will also consider commission based work.

    I can't go into all the details here as it would take far too long! Suffice to say, you can have a very innovation friendly platform as a PLC on AIM.

    Also agree with your comments vis-a-vis Ltd and PLC. It's surprising how many CEOs don't understand this.

  • Cool- I thought as much. Another intersting point to add here just for comment…,

    I was speaking to a CEO of the world's largest mobile phone company (any guesses?) and we were discussing the premise that “Large companies do not innovate: they aquire smaller companies to do that for them”. He agreed with me and we discussed the various reasons behind this (won't disclose that part).

    Interestingly enough I asked him if as a Large Corp looking to innovate would he:
    A) Acquire the innovating company at an earlier stage so as to minimise cost of acquisition? OR
    B) Acquire the innovating company at a market traction stage so as to minimise risk?

    His answer was an absolute and unniquivecal B! In fact he stressed he would rather pay $100M – $1B or more for a strategic acquisition with proof of market and traction, than pay $10M for a company with the potential of it being a $1B company. His board and shareholders just do not let him take those kind of speculative risks!

  • That is good news indeed!

  • Exactly, as this is where VCs take on that risk. The mission being to get that company sufficient market postion, profit potential or at least “perceived market value” such that they can either sell this company or float it. This is the equivelent of the $100M+ home-run.

    Large corporates and the Main markets (market makers) would much rather VCs take this risk. In this way VCs act as a facilitor or accelerator for innovation.

  • Hi Nic, I'm going to disagree and agree with you on this (how typical of me!)

    Agree- Large Corporates (by and large) DO NOT INNOVATE. They aquire smaller and more agile companies to do that for them. I know this first hand from experience as a Business Manager in a Fortune 16 company.

    Disagree- “Public Companies are not set up for Innovation”
    I'm going to presume by “Public” you mean publicly “Listed” companies and are not referring to the whole PLC portfolio of companies, the majority of which are not listed. If you are referring to publicly listed companies then I agree, if you are including all PLCs as an entity then I disagree. Furthermore, we then we have “AIM listed” companies, not “listed” in the sense of being on a regulated market, but close to it. Now if we look at many of the AIM listed companies I would say they are well set up for innovation. They've got access to capital (good for product development, good for founders and recruiting/retaining talent), they've got status and recognition (good for morale) and they haven't got the burden of a large public ownership base (retaining ownership and control) and haven't got all the usual restrictions associated with VC financing. In my view, an ideal platform for fostering innovation!

  • David,

    I've rarely heard good things about AIM (generally: “all the disadvantages of a public listing (reporting, transparency, short-termism) without the advantages (deep pools of capital, liquidity, kudos)”.

    Are your comments based on personal experience? If so that's great – I'd love to hear more.

    (And I'm sure Nic is only referring to publicly listed companies. From an entrepreneur's point of view, a plc and an ltd are just legal structures with no practical difference. It's only once the shares are listed on a recognised exchange that anything changes)

  • Hi David – we are in agreement! I was talking about large publicly listed companies – e.g. the FTSE 250.

    I share Nicholas's reservations about AIM as a home for small businesses though.

  • Hi Nicholas

    An AIM listing can bring enormous value to an emerging company (aside form capitalisation) if done well. And I stress, the term “done well”.

    Let me deal firstly with some of the “failings” or perceived failings of AIM.
    As it is not a registered listing, it's regulations are relatively light and its entry requirments are not restricitve- it enables and sometimes invites a pool of companies to float on AIM who would otherwise not be worthy of such a listing. I am thinking of the numerous investment companies, real estate investment companies, mining companies and media/entertainment companies that have no trading history and float on AIM. For the most part they do not raise significant capital, and unfortunately scew the data as well as draw criticism to AIM.

    Also, as AIM became so successful (both in volume and in liquidity) over the years the NOMADS, Brokers and Lawyers are inflated their fees to such a point that the cost of obtaining an AIM listing became almost prohibitive. This meant fewer and fewer emerging companies could afford the fees to list and relegated AIM to a small niche market for more established companies wishing to access a capital market or for companies who no longer could afford or meet the criteria for remaining on the Main market. In this sense AIM no longer served its purpose as a venue for fostering emerging companies.

    Now for the positives:
    On AIM you don't have a minimum threshold for public ownerhsip, you don't necessarily have to make a public offer either, you can obtain a placing instead. This saves on the cost of the Prosepctus and the legal fees. Your reporting requirements in my view are light. If you can't comply with AIMs reporting requirments then you really have no right to be holding any shareholders' capital imho. THis is not the same as a Main listing reporting requirements.

    Liquidity on AIM is pretty good, and ironically as the volume of new entrants has fallen to a minimum, the volume of capital traded on AIM has largely remained steady. Do the maths and you'll figure out what that means for companies on AIM.

    Furthermore, the market situation has now forced NOMADS, brokers and lawyers to look at charging more realtistic (not inflated) fees. Some will also consider commission based work.

    I can't go into all the details here as it would take far too long! Suffice to say, you can have a very innovation friendly platform as a PLC on AIM.

    Also agree with your comments vis-a-vis Ltd and PLC. It's surprising how many CEOs don't understand this.

  • Cool- I thought as much. Another intersting point to add here just for comment…,

    I was speaking to a CEO of the world's largest mobile phone company (any guesses?) and we were discussing the premise that “Large companies do not innovate: they aquire smaller companies to do that for them”. He agreed with me and we discussed the various reasons behind this (won't disclose that part).

    Interestingly enough I asked him if as a Large Corp looking to innovate would he:
    A) Acquire the innovating company at an earlier stage so as to minimise cost of acquisition? OR
    B) Acquire the innovating company at a market traction stage so as to minimise risk?

    His answer was an absolute and unniquivecal B! In fact he stressed he would rather pay $100M – $1B or more for a strategic acquisition with proof of market and traction, than pay $10M for a company with the potential of it being a $1B company. His board and shareholders just do not let him take those kind of speculative risks!

  • That is good news indeed!

  • Exactly, as this is where VCs take on that risk. The mission being to get that company sufficient market postion, profit potential or at least “perceived market value” such that they can either sell this company or float it. This is the equivelent of the $100M+ home-run.

    Large corporates and the Main markets (market makers) would much rather VCs take this risk. In this way VCs act as a facilitor or accelerator for innovation.