Innovation Killers - Financial Tools & Risk Management
1-Discounted cash flow and net present value, as commonly used, Managers underestimate the real returns and benefits of proceeding with an investment because use of misapplied tools of financial analysis method of discounting cash flow to calculate the net present of the plan. Most Managers compare the cash flows from innovation against the default scenario of doing nothing, assuming--incorrectly- that the present health of the company will persist indefinitely if the investment is not made. So the first error is to assume to not investing in innovation that the present health of the company will continue same into the future if the investment is not made. It’s hard to accurately forecast the stream of cash from an investment in innovation. In most situations, however, competitors' sustaining and disruptive investments over time result in deterioration of financial performance.
2- Fixed- and sunk-cost conventional wisdom give an unfair advantage on challengers and shackles incumbent firms that attempt to respond to an attack. Executives in established companies, complain about the expense of building new brands and developing new sales and distribution channels, seek instead to leverage their existing brands and structures and rely on assets and capabilities that were copied in the past to succeed in the future. Entrants, in contrast, simply create new ones. The problem for the incumbent isn't that the challenger can spend more; it's that the challenger is spared the dilemma of having to choose between full-cost and marginal-cost options.
The argument that investment decisions should be based on marginal costs is always right. But when creating new capabilities is the issue, the relevant marginal cost is actually the full cost of creating the new.
3- The emphasis on short-term earnings per share as the primary driver of share price, and hence shareholder value creation, acts to restrict investments in innovative long-term growth opportunities. These are not bad tools and concepts in and of themselves, but the way they are used to evaluate investments creates a systematic bias against successful innovation. Managers are under so much pressure, from various directions, to focus on short-term stock performance that they pay less attention to the company's long-term health than they might, so they reluctant to invest in innovations that don't pay off immediately. So we should recommend alternative methods that can help managers innovate with a much more astute eye for future value.
The projected value of an innovation must be assessed against a range of scenarios, the most realistic of which is often a deteriorating competitive and financial future.
These tools and concepts in evaluating investments create a systematic bias against innovation. So we will recommend alternative methods that, in our experience, can help managers innovate with a much more astute eye for future value. Our primary aim, though, is simply to bring these concerns to light in the hope that others with deeper expertise may be inspired to examine and resolve them.
