Tuesday, April 12, 2016

How the financial market can be another impediment for the development of disruptive innovation

In the book introduction from “The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail” by Clayton M. Christensen, Christensen describes the difference between sustaining and disruptive technologies and afterwards develops five principles for managers how to successfully deal with disruptive innovations. By distinguishing between sustaining innovations, which most companies can successfully handle with good management, and disruptive innovations, which cause problems to almost all large companies, I believe that he has made a suitable characterization of the different innovation impacts. To appropriately tackle disruptive innovations, “now widely accepted principles of good management are […] only situationally appropriate” and sometimes “it is right not to listen to customers” (both p.4). Because of this reason, the small initial absolute growth for new disruptive products, the non-feasibility of market research for these products, and the non-alliance of existing capabilities for new disruptive markets, he finds that large companies have almost always failed to handle disruptive innovations except for the case that they created autonomous subsidiaries that were responsible for tackling the disruptive technology.

Among these factors, I believe that Christensen should have highlighted another disruption-hindering aspect for large companies: Their integration in the capital market. Except for fast-growing start-up like listed companies, such as Facebook, investors expect a reliable return from stock-listed companies and want to be compensated for additional risk. This compensation for additional risk is embedded in the key financial formula - the Cost of Capital formula that is used in every professionally-managed corporation. The required compensation for additional risk effectively gives management incentives to avoid risk and build on reliable business models. Relying on the in-house development of disruptive innovations is, however, more like a gamble whose chances can be influenced. Besides, the requirement to give forecasts to the market about the expected future earnings more or less forces listed companies to make the by Christensen identified mistake to quantify market sizes and financial returns before a market is entered.

One recent example for the market’s preference for reliable business models is the creation of the Alphabet holding to separate Google’s successful existing business by Google’s development projects that try to create disruptive innovations in unrelated areas. One of the key reasons for this move was to clearly separate the revenues and expenses of both businesses so that investors can better control how much Google spends on these disruptive innovation-driven investments. If investor’s willingness to accept large investment’s into uncertain disruptive developments is even for such fast-growing, innovation- and disruption-famous tech-companies, like Google, limited, it is obvious that this willingness will be considerably smaller for more mature businesses. These businesses might not even have a chance to create a subsidiary responsible for disruptive-innovation because of tight stock market control. I personally doubt that there are many possibilities to change this impediment on a large-scale from the company’s perspective except for the case that either the company itself or the CEO might be particularly famous for its successful innovation approach.

Sources: Book Excerpt: Why Good Companies Fail to Thrive in Fast Moving Industries, from Christensen, Introduction, The Innovator’s Dilemma, 1997.

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