Curious Capitalist

How Bad Mergers Are Killing Innovation

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Wall Street’s disproportionate sway over the U.S. economy has caused big problems in recent years, from the subprime crisis to high-frequency-trading debacles (just look at the new research out from the CTFC showing how speed traders rip off average Joes). But here’s one you may not have noticed: it’s crippling innovation.

To understand how, look at the latest victim, the once mighty Hewlett-Packard. It’s hard to think of a company that’s been as loved and, more recently, loathed. The godfather of high-tech firms, HP was started in a garage in 1939 by two engineers and came to symbolize the Silicon Valley culture of creativity and collaboration.

But that was then. For more than a decade, HP has been plagued by management flameouts, layoffs and slumping profit margins. Now the company is reeling from its Nov. 20 announcement that it is taking a massive write-down on Autonomy, a software company it paid $11 billion for in 2011. HP is erasing $8.8 billion of Autonomy’s value from its books amid allegations of accounting improprieties and disclosure failures. And HP’s stock chart is looking like a downward slope on one of the mountains near its headquarters.

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HP’s real problem—it is one that also troubles the rest of corporate America—is an addiction to buying short-term growth at the expense of long-term innovation that can produce profit and jobs. The Autonomy deal, which many investors felt was wildly over-priced, certainly fit that description. But so did several others, like HP’s 2001 merger with Compaq and its later purchase of tech services company EDS, which became a foil for earnings boosting cost-cutting (at the expense of innovation, say analysts like Rob Cihra at Evercore Partners).

Much of this is down to the fact that executives in corporate America are still rewarded on the basis of stock price and behave accordingly. Many large firms have come to resemble financial institutions, running their balance sheets like portfolios to hedge short-term bets while failing to invest in their future. Over the past three decades, those sacrificing long-term growth for short-term gain have included companies ranging from Kodak and Merck. Suffice it to say the list is long and, thanks to ever-shorter investor time horizons, growing.

This problem really took off in the 1980s, which is when finance itself became a much larger percentage of the economy. Research from the Kauffman Foundation, which studies entrepreneurship, has found that the number of new businesses created in the U.S. has actually floundered as banking has come to represent a bigger part of the economic pie (which, not incidentally, is exactly the opposite line we were sold during the banking bailouts).

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But even less well understood is the way in which financial thinking has come to dominate corporate America, in part because corporate leadership is increasingly plucked from finance rather than from industry and manufacturing as it was during the 1950s and 1960s. “Corporate culture tends to reflect the culture that leaders come from,” says Kimberly Elsbach, a professor at the University of California at Davis who co-authored a paper last year titled, “The Building of Employee Distrust: A Case Study of Hewlett-Packard from 1995 to 2010.” To the extent that more and more business leaders take their cues from banking, that may bode ill for the U.S. economy.

6 comments
twymantowery
twymantowery

This article was right on point to my experiences with today's corporate America and I wish was required reading for all budding MBAs.  But the same rationale applies to with present day personal expectations/ambitions of employees, professional or otherwise. I remember my preceptor in Hospital Administration (for my grad degree in Medical and Hospital Administration) told me that when I took a job I owed my employer at least five years loyalty (and that sentiment was widely accepted). Almost anything over six months would be laughable in today's fluid job market. The apple doesn't fall far from the tree!

computerhoncho
computerhoncho

Putting balance sheet together is an accounting trick.... to develop smartphones and Google requires a little more gray

matter... see for yourself ....

bryanfred1
bryanfred1

If management's job is to build shareholder value then stock price performance is a fine barometer - the problems arise when the compensation structure focuses on short-term rather than long-term performance.  Also, since the passing of Sarbanes Oxley entrepreneurs increasingly start and grow businesses with the express intent of selling them to the 800 pound public gorilla instead of getting to an IPO (at least in the U.S. - London and Hong Kong have picked up some of the slack).  That means fewer independent companies with IPO proceeds developing new products and services.  The problem with being HP's size is eventually you become the market and can't grow any faster than overall demand for your industry's products.

Ol'Bob
Ol'Bob

HP's slide started when they decided to STOP being an innovator and start being a "products company".  Getting rid of the test equipment business, cutting the heck out of calculators, and buying Compaq were the signs that they were headed down the tubes.  Carly Fiorina led the charge into the toilet, and nobody since has had the sense to head back to something resembling sanity.  What IS HP anymore?  Just another mediocre company waiting to go broke, IMO.  An American icon, screwed to hell'n'gone in the quest for more profits.  I doubt they can be saved...

DavidBell
DavidBell

This column is what results when you give an ideologue a pen.  Because HP has been mismanaged for 10+ years, it means that Wall Street no longer allows innovation?   I'm sure that Apple, Amazon, Walmart would all be disappointed to know that they can no longer develop new products and services.

The financial services sector does have an over-sized presence in the economy.  But, your guy just got re-elected, and he has done nothing to control the rampant abuse on Wall Street.  His buddy, Jon Corzine, stole $1.5 billion from his clients to bet on Euro bonds, but lost.  DOJ wasn't able to find any evidence of wrong-doing.  Not a single contributor to the collapse of the economy in 2008-2009 has gone to jail.  

racqueteer
racqueteer

@DavidBell How you turned this into a Rush Limbaugh political rant is beyond me. You seem to be saying "Yes, you're right, but I think you voted for Barack Obama, therefore I must repudiate you while at the same time agreeing with your initial premise."