Encouraging the right type of innovation

Clayton Christensen article in the New York Times last weekend which argues that the poor performance of the American economy is explained by a lack of empowering (i.e. job creating) innovation. This is, I think, an important point. Fred Wilson has since blogged twice about it.

Christensen’s argument has three tenets:

  • The economy is in bad shape, as evidenced by the fact that whereas it used to take six months for employment to recover after a recession this time round we are at 60 months and counting (stats are for the US economy)
  • It’s in bad shape because managers everywhere make investment decisions using Return on Capital Employed (ROCE) or Return on Net Assets (RONA) models which lead them to seek efficiency innovations which improve profits but eliminate jobs
  • What is needed is a longer term perspective allowing investment in empowering innovations which create jobs

His definition of empowering innovation:

[Empowering innovations] transform complicated and costly products available to a few into simpler, cheaper products available to the many.

The Ford Model T was an empowering innovation, as was the Sony transistor radio. So were the personal computers of I.B.M. and Compaq and online trading at Schwab. A more recent example is cloud computing. It transformed information technology that was previously accessible only to big companies into something that even small companies could afford.

and of efficiency innovation:

[Efficiency innovations] reduce the cost of making and distributing existing products and services. Examples are minimills in steel and Geico in online insurance underwriting. Taken together in an industry, such innovations almost always reduce the net number of jobs, because they streamline processes.

Christensen is one of my favourite thinkers and there is an awful lot in this (if you have time please go read the full article, it loses a lot in the summary), but I think the relative absence of empowering innovation is more down to our collective impatience than the use of ROCE or RONA models. I wrote the following in a comment on one of Fred’s posts:

I think the problem with the ratios is a subtle one. In theory empowering innovations should have a big enough ‘R’ that the calculations work out fine, but in practice most execs don’t feel comfortable putting big returns delivered over the long term but with low probabilities of success in their models – it opens them up to ridicule. So they look for smaller goals that can be achieved quickly with a high probability of success, which leads them to efficiency innovations.

This problem is made worse by the short time frames that society works to these days. Most people don’t expect to be in the same job for the 5-8 years most big innovations take, and most shareholders are operating to much shorter time horizons.

I was talking last night about the short termism in politics and a friend observed that people almost always vote to have more today even if it will sell their children (or even themselves) short in the future. You can see that in public sector deficit figures and the lack of action in the environment. I think we collectively do this because we highly discount the future. We evolved when life was nasty, brutish and short and in that environment investing in the long term (say ten years) made little sense. That type of thinking is still with most of us.

I wonder if that same thinking mitigates against empowering innovation – most people feel better making small gains over a short period of time rather than struggling for a long time in search of a big win.

Whilst I might differ with Christensen on why we have less empowering innovation I’m 100% with him that we need more. Our inbred short-termism will always be a challenge, but in the past strong individuals fighting for the greater good have come to the fore and I think there are a few things that can be done to encourage more people to do that now:

  • Encourage investment in empowering innovations via the tax code. Christensen suggests that capital gains tax should decline with the length of time an asset is held (we used to have that in the UK), and tax incentives to invest in longer term riskier assets are also a good idea (like the EIS scheme here in the UK).
  • Improve understanding that empowering innovation is what we need to provide air cover for those individuals brave enough to embark upon it. That is part of my purpose in writing this post.
  • Celebrate true invention and empowering innovation to a much greater extent than efficiency innovation. We do this already to an extent but being clear that empowering innovation is what we need will help.

The good news is that a lot of this is happening already. The UK and US governments now get the fact that innovation (and startups) are the engine of growth and job creation, and entrepreneurialism is increasingly cherished within society more widely. We just need more of it.