Clay Christensen at the RSA in a talk titled “The Capitalist’s Dilemma”.
Photo by Kevin Anderson, Some Rights Reserved
Disruptive, or empowering innovations, create jobs, but they take time to pay off, while efficiency innovations eliminate jobs and free up capital (save money) in the short term, Harvard Business School professor Clay Christensen said in a talk entitled “The Capitalist’s Dilemma” at the RSA in London last night. The problem he sees is that management has become a conversation almost entirely focused on spreadsheet-driven financial targets and short term efficiencies rather than longer term value creation, which also creates jobs.
If you’re not familiar with Christensen, he sums up the focus of his work in the preface of The Innovator’s Solution, a book he wrote with Michael Raynor. He says:
It is easy to explain why poorly run companies fail; but many of history’s most successful and best-run firms have lost their positions of leadership, too. Why is so hard to maintain success?
Christensen looked at disruptive innovation, or what he called empowering innovation last night, and why incumbents were overthrown by upstarts. In some industries, such as the case with newspapers, they recognised the disruption but were still unable to adapt. I’ve written two pieces for The Media Briefing, looking at Christensen and his former Harvard colleague Clark Gilbert‘s advice for the newspaper industry and how they can adapt.
Last night, Christensen was talking about innovation in much broader terms and looking at the affect of focusing on short-term cost-saving innovation versus longer term empowering innovation.
What he wanted to understand was why unemployment has been taking longer to return to pre-recession levels since the recession in 1990. What was interesting is that he was looking not just at unemployment but more precisely the “lag from when real GDP returns to the pre-recession peak to when employment returns to the pre-recession peak”.
Click to go to Flickr for the full-size image. Photo by Kevin Anderson
As you can see from the graph, looking at recessions in the US from 1948 until now, the average lag was six months, but then the lag began growing from 15 months to 39 months to the current lag after The Great Recession. Sixty months after it began, and we still don’t know when unemployment will return to pre-recession levels. What is causing these jobless recoveries?
To put it succinctly, he blamed a short-term focus driven by the financial models easily run in spreadsheets by “26-year-old analysts”. He summed it up the theories and the practice of finance that is leading to this short-termism in this table.
|A theory of finance
||Tools of finance
|pre-eminence of returns on capital
||spreadsheets – Visicalc, Lotus, Excel
|calculus needs something to maximise
||measurement via ratios
|Milton Friendman gave the target
||NPV (Net present value)
|Guided by Delaware courts, not legislation ever since
||Management becomes the assembling, optimising and shipping of numbers.
Created with the HTML Table Generator
Just to look at the power of spreadsheets, he said that they were the biggest recent development, adding:
A 26-year-old can build the financial models of companies and effortlessly test the impact of different inputs onto outcomes that matter.
He said that business is now driven by “the church of finance”, in which finance becomes a religion both in terms of how it is taught and the level of belief of its adherents. With the true believers of finance driving management, decisions are boiled down to measuring the efficiency of deploying capital.
Christensen explained the effect of this finance-driven focus through his framework of innovation. He sees three types of innovation:
• Empowering, which make the expensive and inaccessible, cheap and accessible.
• Sustaining, innovation that simply replaces an old model with a newer model
• Efficiency, “These reduce the cost of making and distributing existing products and services,” as he wrote in the New York Times.
Empowering innovations create jobs but they use capital, and they are longer term investments, often taking five to 10 years to see a return. “Efficiency innovations pay off in a year or two. Instead of using capital, they save it,” Christensen said, but instead of creating jobs, they eliminate them.
The problem he sees in the US (and the UK, although he wasn’t ready to say that will full confidence) is that he estimates there is now a third of the empowering innovations being created as there were in the 1950s, 60s and 70s.
Why is the US economy so anaemic? It isn’t weak corporate balance sheets. He said they were “pristine” and stronger than they had been in years. The problem also isn’t lack of capital, and he said over and over that the US is awash in capital, which is why private equity and hedge fund managers say that so much money is chasing so few deals these days. The problem is that the “finance mechanism hijacks capital and recycles it unto itself”, Christensen said.
That’s the problem, and he did point to a few solutions. For one, he said that capital needed the will to invest in longer term, empowering innovations. He pointed to the US tax code that punished short-termism by charging the personal rate of tax on investments of less than a year, which for top-bracket income earners would be 35 percent. However, if you hold that investment just one more day, 366 days instead of 365, then the tax rate drops to 15 percent. He said that 366 days is not the kind of long-term investment that will spur empowering, job creating innovations. Instead, he recommended low or zero taxes on money invested five to eight years.
He also criticised the solutions spun by the Democrats and Republicans, the two dominant parties.
I think the Democrats and Republicans are both wrong on this redistribution issue. In the US, the top 1 percent own 28 percent of disposable income. The Republicans say that we have to let them keep their money to invest in jobs. Most of them don’t invest in jobs but use their capital to create more capital.
The Democrats are wrong as well.
If we don’t have empowering innovations, the solution isn’t to redistribute wealth in the other direction, which is in line with the Democrats efforts to increase taxes on higher income brackets. I like how Christensen put this in the New York Times:
If the I.R.S. taxes their wealth away and distributes it to everyone else, it still won’t help the economy. Without empowering products and services in our economy, most of this redistribution will be spent buying sustaining innovations — replacing consumption with consumption. We must give the wealthiest an incentive to invest for the long term. This can create growth.
Of course, one of the great debates in our current politics is how to deal with rising debt in our societies. Christensen is pro-growth, and when asked whether “we can say definitively that austerity doesn’t promote prosperity”, he said very quietly, “yeah”. However, Christensen seemed to nicely get around the gridlock of the current debate on how to deal with the debt. However, he does admit in his article in the Times that the issues are complicated.
Innovation and journalism
For me trying to think about how innovation affects journalism, I had one take away. When a product becomes commoditised, it opens up opportunities both above and below the commoditised project. I do believe that the over supply of information has commoditised much of breaking news such that as Christensen pointed out in a 2011 study:
The wealth of information available almost instantaneously has lowered the value of the general interest news story such that it’s often less than the cost of production. General interest and breaking news reporting comprised of answering the “who, what, when and where” has become commoditized. It cannot create enough value to sustain a news organization in the long term.
The question becomes what opportunities exist above and below the commoditised “general interest news story”. What could those products be? It’s a good question, and it’s one of the reasons why I bought a copy of The Innovator’s Solution after the talk. I managed to get a few seconds with Christensen after his talk, and I thanked him for his research in 2011 and asked what he would recommend in terms of how to work within a traditional news organisation. His answer was sobering, but that will have to wait for another blog post.