Finding an Ideal Metric for Innovation
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.