June 13, 2014
The Capitalist’s Dilemma

To boost growth in the U.S. economy and pull out of the economic slump we’ve been in for the past few years, we need to look at the reluctance of corporations to invest capital into market-creating innovations. Harvard Business Review published a recent article on the capitalist’s dilemma, acknowledging that the tools we use to guide our investments are blind to the best opportunities for creating new jobs and new markets.

Types of Innovations

Before we can make changes to the system, it’s important to understand the three different kinds of innovations that exist:

Performance Improving Innovations

Performance improving innovations typically replace old and outdated innovations. These innovations create relatively few jobs because they are simply replacing an old good or service, rather than creating a new good or service. Customers rarely buy both an old product and a new product. For example, if a customer buys a Toyota Prius, he or she is unlikely to buy a Toyota Camry as well.

Efficiency Innovations

Efficiency innovations are innovations that take mature, stable products and figure out a way to make them more efficient so they can be sold to the consumer at a lower price. Walmart and Geico are both examples of leaders in efficiency innovation. Two important factors come into play when dealing with efficiency innovations. The first is that these innovations raise productivity by helping maintain competitiveness, but unfortunately result in increased layoffs. The second is that these innovations free up company capital so it is available for more productive uses.

Market–Creating Innovations

Market-creating innovations create a new class of consumers and potentially a new market. Two critical ingredients to market-creating innovations is that the innovation must enable technology which will drive down costs as volume grows and create a new business model that will allow the innovator to reach people who have not been customers.

The smart phone is a prime example of a market-creating innovation. Mainframe computers were available to very few, were not very common to use and were incredibly expensive. These computers led to the eventual invention of the personal computer, which became more widely available to and affordable for consumers than the initial mainframe computer had been. Today we have smartphones that are available all around the world, mini-computers to which countless people have access.

The Capitalist’s Dilemma, then, is that we are too often focused on where the capital is in the innovating process. Corporate performance should be focused on how efficiently capital is used, rather than how much capital is used. There is plenty of capital lying around in the world, so let’s use it!

Market-creating innovations often take five to ten years to pay off and are a bit riskier. However, in the long run they will be more successful than efficiency innovations and performance improving innovations. They just need capital to grow. Focusing on financial outcomes too early on in the innovation process will result in a lack of ambition. We must resolve to never begin or end an investment conversation with reference only to a spreadsheet.

Renewing The System

Four steps can to be taken to potentially renew the system and begin a trend of market-creating innovations:

Repurpose Capital

There are three types of capital to consider. The first is timid capital, which is risk-averse and chooses to make no investment over an investment that might fail. Migratory capital comes next, and is capital that enters and exits as quickly as possible, grabbing onto as much additional capital as it can, and enterprise capital likes to stay put once injected into a company. To resolve the capitalist’s dilemma, both timid and migratory capital need to be convinced to stay in one place, becoming enterprise capital. One possible solution for this is to reward long-time shareholders for their loyalty and investments.

Rebalance Business Schools

A lot of the blame for the capitalist’s dilemma unfortunately comes from business schools. Programs such as strategy and finance need to be taught together and not separated from one another, as is the current practice. Because the functions of both of these programs are dependent on each other in the real world, we need to teach them this way, or the logic of finance will always take precedence over strategy.

Realign Strategy and Resource Allocation

Leaders need an internal tool for analyzing the innovation pipeline and the prospect for growth that this pipeline contains. We need to be realistic about the cost of capital, which will in turn make investing for long-term easier.

Emancipate Management

Management is taught to focus on making the short-term investors happy. We cannot please both short-term and long-term investors, so the focus should be shifted to maximizing return for the long-term shareholders. Remember to use spreadsheets to compliment strategic decisions, not replace them.

By attempting to understand and frame the capitalist’s dilemma, the hope is that we can work through these issues to invest in better innovations and find economic prosperity.