Finding an Ideal Metric for Innovation
Finding an Ideal Metric for Innovation
In an in-depth conversation, Clayton Christensen reveals how metrics play a role in innovation.
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Once upon a time, Clayton Christensen tells me, business thinkers
openly questioned if Walmart could compete with traditional department
stores.
We're sitting at an oval table in a small room at Steelcase's Boston
headquarters. We're slamming Diet Cokes. There's a blank whiteboard
behind me. Using the wheels of his chair, Christensen rolls from the
table to the whiteboard and draws two basic multiplication formulas in
green marker:
40% 3x 120%
20% 6x 120%
The upper formula represents how department stores created 120%
returns on capital invested in inventory. Their margins were 40%, and
they turned over their inventory three times a year. Forty times three
equals 120.
When Walmart came along, Christensen says, there were skeptics who
wondered whether their 20% margins would allow them to compete with
department stores. For the skeptics, it was a simple matter of 20%
margins being less than 40% margins. Only when they realized that
Walmart turned over its inventory six times a year--therefore creating
the selfsame 120% returns on capital invested in inventory--did the
skeptics realize how competitive Walmart could be.
The point of the story, he says, is that "the formula has to be different." But the bottom line result has to be the same.
The formula--really, formulas--in question are the metrics
investors use to gauge how efficiently companies use their capital. You
know the story: Investors (the vast majority of whom hold company shares
for less than a year) want results every three months. Leaders are
judged by their ability to produce those results.
Finding the Right Formula
But that short-term thinking leads to the risk-averse hoarding of capital.
And that hoarding prevents companies from making the growth
investments--in people and in assets--that long-term innovations often
require. "Any metric that's finance-oriented focuses you on the wrong
causal mechanism for growth," says Christensen, the Kim B. Clark
Professor of Business Administration at Harvard Business School. "The
[ideal] metric must allow you to assess growth for the future."
Right now, Christensen would love to find that ideal metric: The one
that will enable (and ennoble) leaders to make the best long-term
decisions for sustained growth and innovation without
displeasing investors. Both leaders and investors, he says, need "a
cognitive baptism" to the idea that "growth doesn't come from
efficiency."
Which brings us back to the multiplication formulas. How do you get
leaders to see that acing the equations for capital efficiency isn't
ideal for their company's posterity? How can you tweak the formulas in a
way that will somehow produce a systemic change in capitalistic
thought--yet still produce comparably high bottom-line results?
Asking the Tough Questions
For now, these remain open questions. It's a place to start. And it's how Christensen generally works.
When Christensen was an MBA student at Harvard, he had a habit of
writing down the best questions he heard in class. At the end of the
day, he reviewed the list, seeking traits and patterns that separated
the most brilliant questions
from the ordinary ones. His longtime collaborator Hal Gregersen,
executive director of the MIT Leadership Center and a senior lecturer at
the MIT Sloan School of Management, once told me that.
His approach evokes Peter Druckers's classic quote from The Practice of Management (1954): "The important and difficult job is never to find the right answers, it is to find the right question."
Beyond starting with the right questions, Christensen has one other
suggestion he believes would help companies do the right long-term
thing. The suggestion--more of a provocation at this point than
something leaders can take action on--is to somehow classify investors
by their long-term interest (or lack thereof) in the company.
How to codify this classification is another open question. But the
general notion is this: Short-term investors are like tourists.
Long-term investors are like residents. Most communities base their
fiscal decisions on what's best for residents. They don't altogether
ignore the tourists--and the revenues they bring--but there's a general
recognition that the residents have the first or only say. "Tourists
can't vote," is how Christensen summed it up during the "Capitalist's Dilemma" talk he gave, prior to our Diet Coke summit.
If companies could somehow find a way to create a preferred class of
shareholders who were like residents--or to relegate the rights of
tourist shareholders so that they had less of a say--that would be a
first step.
Pie-in-the-sky thinking? Arguably. But if the tourist-resident binary
isn't convincing enough, consider the seize-the-day business lessons of
the 1990s and early 2000s. During that time, Christensen says, the US
was "awash in bandwidth." There was a large supply of it, available at a
relatively low-cost. Some companies sat on their hands and horded their
capital. They burnished their balance sheets. But a few
companies--Netflix, Google, Amazon--spent their capital making major
bets on the bandwidth.
You know who won those bets.
The larger lesson is another old-school principle, from not only Drucker but also legendary marketing guru Theodore Levitt. Christensen cites them in his soon-to-be seminal HBR essay
on "The Capitalist's Dilemma." Both Drucker and Levitt, he writes,
urged leaders "not to define the boundaries of our businesses by
products or SIC codes but to remember that the point of a business is to
create a customer."
And you don't create new customers by just sitting on your capital.
All you do is please the investors who are here today and gone tomorrow.
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