Is “Pursuit of Profits” the killer of Innovation and the U.S. Economy? hmmm..I don’t think so


I saw this today morning on twitter via Frank Scavo

http://www.forbes.com/sites/stevedenning/2011/11/18/clayton-christensen-how-pursuit-of-profits-kills-innovation-and-the-us-economy/

It is an article on Forbes.com by Steve Denning, based on a talk at the Gartner Symposium ITExpo 2011 on October 16-20, 2011, given by Clayton Christensen.

While I have a lot of respect for Christensen, I don’t think all the arguments made forth in the article are reasonable. I do think some of them have social merit, although I doubt they make economic sense. Here are my thoughts for what it is worth. Of course, this is just my personal view, not that of my employer.

The Dell Example

So Dell did outsource most of what it does, and it does not look smart anymore. Makes perfect sense to me – but, that does not prove everyone who outsourced got burned.

The icon for American innovation -Apple – heavily depends on Foxconn in China for the profit margins of iPads. Does that make people say Apple is less innovative ? If Apple moved manufacturing jobs to US, it probably will lose a third of its profits (I guess..have not researched ). So it might not make direct sense economically, but definitely makes sense socially leading to indirect gains on economy too. Many more Americans will get jobs, but then either Apple will have less returns for its investors, or iPads will cost more – thereby reducing its appeal somewhat.

Dell and Apple are at 2 extremes probably. All I am saying is that for every extreme example used to make a point, there is almost always an extreme counter example.

There is one point I fully agree – if you outsource your core competence (assuming you can even define what it is in the first place), you have just booked your ticket to a chapter in the history books. Apple still keeps design in US so far from what I understand, and it helps them be in control. If Macro-economic conditions favor them, they could very well bring the jobs from China back to the US.

Business schools are to blame, but only in part

It is not the first time B schools get beaten up for everything that is wrong, and some of it is absolutely well deserved. But I don’t think B schools should be beaten up for teaching that profitability is a good thing, and that it is the ultimate goal of a business. Also, I don’t think anyone makes investment decisions based on any one ratio like IRR or RONA or any other ratio for that matter. B schools do teach that trusting any one ratio without context is a terrible way to make a decision – at least the one I went to did. Decisions are made by looking at a bunch of ratios in relation to each other, and then by absolute numbers and comparison to benchmarks, and finally by the experience and judgment of managers. In real life, it would take forever to make decisions without some help from ratios.

Where I agree wholeheartedly is that some financial analysts dumb down these ratios to compare companies which have no similarity. That is not the fault entirely of business schools – it can be argued that it is the fault of the business itself. Business Schools just ape what seems to be SOP for business. Over time this is a chicken and egg problem – trying to figure out if academia started it or some one in the street started it. In short – B Schools at best should only be blamed for some part of the problem.

The case of Fabless companies – did they really miss the point?

From the late seventies / early eighties when fabless started to today, that industry moved from just about a million dollars between 3 companies to the top 3 companies ( Qualcomm, Broadcom etc) making about 15 Billion dollars or so today, and growing steadily. These companies do the design and then trusts contract manufacturers to build. The one company that does all manufacturing by itself – Intel, is also now going after the business of letting other companies use its terrific foundries. And where does Intel do all its manufacturing – is it in US? Nope. Semiconductors are very cyclical, and innovation typically outpaces the ability to keep up investment in fabs to match it. So there is a higher threshold for entry into this field. As long as design capabilities ( design in/ design win) remain in US, why would US lose out?

As things get to a stage in maturity curve when the manufacturing process is fairly repeatable, I would argue it continues to make sense to outsource the repeatable process. The innovative part – the brains which do design – are the ones that should not be outsourced. The resources saved by outsourcing can then be utilized for the next round of innovations. There is only so much investment to go around – just as we did not hold tight to horse buggies when it became possible to mass produce cars, we should not hold on to the past just to be extremely risk averse. if we do so – then we will not be able to invest in further innovation.

There is an angle of incremental innovation vs disruptive innovation that should be considered. Outsourcing can probably hurt the incremental innovation side quite a bit. However, if the money saved by outsourcing is reinvested partly to R&D for disruptive innovation – can’t it be argued that it more than makes up for the opportunity cost?

Cost accounting surely needs to evolve

I readily agree here. We have to understand that the world is not static, and there are always new types of costs that need to be addressed. But this is also subject to interpretation to a large extent – it is a best guess to compare opportunity cost of “lost knowledge due to outsourcing” to “investment in new innovation”. The reason is that in both cases – it is only after the fact that we can see what the benefits truly are. So this is not a concrete argument, although it has some merit.

Customer delight vs Profitability

This is where I have the biggest disagreement. If the end result is customer delight, and profitability is not an objective – why is Apple not selling iPads for $50 or for cost or free even? Obviously customers will be delighted if the price is lower with the same set of features, right? The reason is simple – the company that is not profitable cannot invest in innovation, or reward its employees enough to delight the customers on a sustainable basis. Customer delight is a great means to an end – not an end in itself.

In every case, customer is not the king. When something new comes into the market that customers like, sellers are the kings. Semiconductor industry is an excellent example – they ran on quota basis for a while, but cannot do so for the last few years. Once competition starts heating up, sellers cannot take the same attitude – and slowly make customer the king, and try to delight them. But seller’s motivation is always to make the next thing that makes them king, and ride the next wave. If you just try to ride any one wave for long – you risk the chance of booking the history chapter ticket. IBM and Apple and many others have proven this already in history.

What is killing the US economy and Innovation then?

In my un-researched opinion, it is due to multiple factors – which need comprehensive long term policy changes . Education is one area that I think where US needs to concentrate the most. Without Science, Math, Design skills etc being encouraged big time – it will be hard to remain competitive over time. Immigration is another – why wouldn’t US want to keep the large chunk of students who come here for higher studies, instead of making it difficult for them to get visas and permanent residence? And about taxes – why would we not have tax laws that make it attractive for US companies to bring back money home from abroad?

This country has solved some of the biggest problems that mankind ever faced. I would think these problems we face today on the economy can be solved too with our collective will – if only people can let go of the left/right type thought process and other petty differences and instead look at the problems with the sole objective of solving them.

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10 thoughts on “Is “Pursuit of Profits” the killer of Innovation and the U.S. Economy? hmmm..I don’t think so

  1. Pingback: Is “Pursuit of Profits” the killer of Innovation and the U.S. Economy? hmmm..I don’t think so reblogican.com | reblogican.com

  2. Vijay, I agree with your take on the Christensen article for the most part. On your Apple v. Dell comparison, my take on Apple and Steve Jobs philosophy is that there is a long-term strategy and focus in play. Apple does not sacrifice the long-term for the quarterly results. American companies in particular have become shackled to managing to Wall Street’s quarterly expectations. The companies that can balance short and long term performance should fare better than those who focus on the next quarter. Regarding “customer delight”, the company that manages to produce products that consumers love will be the innovative ones that manage to stay vital and growing.
    Finally a word or two on education. My wife teaches high school pre-Calculus and Calculus. The failure of the education system is a shared failure from the home to the halls of Congress. Education here has become a commodity and not a privilege. In many homes, parents are unwilling to demand performance and study from their children and then blame poor results on bad teachers. The education system itself has become a bloated, top-haevy, inefficient bureaucracy that is more concerned with honoring tenure than teacher performance in the classroom. And those are just the top few gripes on my wife’s list.

    • Kevin, I fully agree with you and your wife.

      First regarding Apple – they definitely have managed to balance short term with long term, and have also managed to delight customers while remaining highly profitable. The question that future will answer is whether they will continue to do so past Steve Jobs. I just finished reading his biography – and it is quite clear that he is very much a fan of profitability. When Woz wanted to give away innovative stuff for free to hackers, it was Jobs who wanted to stop that model, and charge money instead.

      Finally on education – I agree 200% with your wife here. It is not the teachers alone who are the cause. It is a deeper issue that has many causes – and parents have to pick up their fair share of the job. Media, teachers, parents, politicians etc all have to come together to solve this, but I agree fully that parents probably are best suited to lead the charge here.

  3. Vijay, I’ve got to disagree with you on this one. I’m not sure if the Forbes blog is a good rewriting of Christensen’s point, but this passage in your blog I just can’t agree with:

    “This is where I have the biggest disagreement. If the end result is customer delight, and profitability is not an objective – why is Apple not selling iPads for $50 or for cost or free even? Obviously customers will be delighted if the price is lower with the same set of features, right? The reason is simple – the company that is not profitable cannot invest in innovation, or reward its employees enough to delight the customers on a sustainable basis. Customer delight is a great means to an end – not an end in itself.”

    I think misses the fundamental point, which I think the Forbes article is making. Contrary to your example, the idea that customer delight is a worthy end does not preclude the pursuit of profitability. It only precludes the pursuit of profitability above all else.

    Indeed, profitability is a means to whatever end the company pursues. A company cannot meet any other ends if it cannot remain a going concern.

    But let’s consider your example. If Apple were able to figure out a way to remain a long-term going concern (that is, maintaining its product quality, innovation engine, and engineering, design, and executive talent) while taking a huge loss, why wouldn’t they just start giving away iPads? I think it is quite probable that Apple would do just that.

    Unfortunately no one has found a way to run a company like this. So the pursuit of profitability remains a necessary means to achieving an end. But it isn’t an end in itself, and indeed the pursuit of profitability above all else can destroy a company outright.

    • Ethan, I have to disagree with your disagreement 🙂

      Customer delight in itself it not a realistic end for a business. A business is funded by someone who needs to see a return on their investment. Customer delight is not the return…it is a means to profit, which is the return. Apple – or specifically Steve jobs – is an example. When Wozniac wanted to give away Apple’s innovations for free, it was Jobs who wanted to change that model and start charging money for that. With that background, do you think Apple “really” is after customer delight and not profitability? Essentially – i would argue that if Apple had a way to delight customers while running at a loss – they WILL NOT ever take it.

      profit = revenue – cost.
      Customer delight will increase revenue, and assuming cost remains the same, it will increase profit.
      The other part that can increase profit is a reduction in cost.
      Maybe the SRM folks have a “Vendor delight” factor to reduce cost too 🙂

  4. Vijay, I agree with many of your points, but disagree with assumption that it inherently makes sense for manufacturing companies to outsource production “As things get to a stage in maturity curve when the manufacturing process is fairly repeatable”. In some cases, this is definitely the case, but in many others, where the “manufacturing process” itself is the major source of the know-how, it can be extremely counterproductive and loss of significant IP (and creation of future competitors).

    The core disconnect between the profit motive and innovation is one of temporality and the planning horizons that many North American and European companies function within. If you, as CEO, are measured on your quarter-to-quarter performance, you’ll certainly be less likely to make investments that pay off years down the road, regardless of the fact that those investments may be in the best interests of all stakeholders.

    We have to shift to new measures of corporate performance beyond “what have you done for me lately”. We’ve clearly seen that in many state-run industries, multi-year and in fact multi-generational thinking and planning is the norm. That can be a profound competitive advantage over the long haul.

    • If manufacturing process and not design is your core competence, I agree that getting it fully outsourced is not a great idea.
      Plus, outsourcing does not have to be an all or nothing scheme. Nothing prevents you from staying involved via joint ventures etc to keep in close touch with the process if you care to.

      CEO compensation is usually tied to stocks that vest in few years. It can be argued that 3 to 5 years might not be enough time to be really long term. But somehow, CEO pay should be tied to the tenure in office too. So it is a hard thing to do in reality. The quarter to quarter thing is an unncecessary restraint that analysts, pension funds and mutual funds brought into the equation. They take the “in the long term, we are all dead” kind of attitude to valuing stock. And CEOs get punished for missing quarters irrespective of whether they manage to quarters or not.

      I wonder if the street will change its habits, since without such a change – it is kind of pointless to expect CEOs to go all the way themselves. A few companies seem to work wonders in striking shortterm/longterm balance though – like AAPL, IBM etc. For example – IBM went ahead and announced a 5 year EPS roadmap, and while they remain committed to long term – the company has not done terribly quarter to quarter either. (Of course I work for IBM, and hence biased 🙂 )

  5. Hello Vijay,
    Outsourcing and globalization issues keep regenerating themselves time and over again. Sometimes to highlight a success and sometimes the opposite.
    Foundation has to be strong.

    Kumud

  6. Vijay – you’ve hit the nail on the head here. One other major problem is the lack of investment in school teachers to train our kids to be more innovative and creative from a young age. If you pay peanuts, you get……….

    Phil Fersht

    p.s. Drop me a mail, would love to discuss this further with you: phil.fersht@hfsresearch.com

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