Q&A: Why U.S. Companies Fail to Innovate

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Davosians have been raving about Harvard professor and innovation guru Clayton Christensen’s performance on our TIME Davos panel “Leading Through Adversity” on Jan. 23. So I caught up with him in the World Economic Forum’s bustling Congress Center to dig deeper into the root causes of the innovation lull in the U.S.


Why are answers to what’s causing risk-aversion in the economy so elusive?

There’s no consensus — both inside of companies and inside the economy — because there’s no common language or agreed-upon way to frame this problem. Often, in investments and innovation of any kind, if you ask the question “Should we do it?” you never get the right answer. Management teams aren’t good at asking questions. In business school, we train them to be good at giving answers.

For example, your industry, media, is being badly disrupted. And the question is not “Should we shut the business down?” It’s “Where else in the market are people making money?” And if you don’t ask that question then the conclusion is, “We have to keep the existing business.” In education, at Harvard Business School, we’re getting disrupted by online learning, but if we don’t ask the question “Where in the value chain in the future is money going to be made?” we view online learning as a threat rather than an opportunity.

(MORE: Davos Crib Sheet: Top Global Risks of 2013)

In which industries are companies asking the right questions?

It isn’t industry-specific. There are singular bright lights. In media, the Washington Post asked really good questions when my first book, The Innovator’s Dilemma, emerged. Businesses that distribute information and news are in the business of training and teaching people. So WaPo bought Kaplan and a bunch of other businesses where you can learn on the job, and those have become so successful that whether or not WaPo makes money is irrelevant. In contrast, almost all the other daily newspapers never asked the question, and they just missed the opportunity to grow.

At Harvard Business School, we’re facing a huge growth opportunity as more people learn management on the job through corporate universities like Intel University and Goldman Sachs University. If you frame it that way instead of as a threat, we have so much we could offer them to teach their employees more remarkable things.

You mentioned on the TIME Davos panel that integrated companies, those that operate across the supply chain, are more innovative. What’s a good example?

In the auto industry, Mercedes and BMW are integrated. They make almost everything they use. In contrast, Chrysler outsources everything. When an innovation emerges, it’s very hard for Chrysler to respond to the opportunity, because they can do it only when a group of independently operated suppliers agrees on a common course of action. Also, most American companies look at profitability in terms of the return on capital invested, which prioritizes short-term investing and outsourcing. Mercedes measures profitability by dollars per car.

(MORE: Are Today’s Business Leaders Too Afraid of Risk?)

Why do American and European corporations measure profitability differently?

American executives say they are imprisoned by the way equity analysts measure profitability, and that discourages integration and long-term thinking. Measuring profitability in terms of the return on capital invested was the right thing to do from the 1930s to 1960s, when capital was scarce. But now capital is abundant, and it doesn’t make sense to measure profitability that way. If the cost of capital is zero, investments that don’t pay off for five years look the same as those that pay off sooner. So there’s less risk in investing for the long-term.

How should companies measure profitability?

Imagine measuring the return on investment in your employees. The company invests in you so that you know all the nuances about, say, accounting and management, so you can ask really interesting questions. There are 10 million jobs in the world, and 4 million of them are in the U.S. and companies can’t fill them. They should invest in bettering their people, and then revenues become a by-product of their investments.

More companies are bringing U.S. manufacturing jobs home. Does that indicate a longer-term view of profitability?

Some companies are making announcements about it, but they can’t be serious about it unless they start measuring profitability differently.

(MORE: Four Keys to Decoding the World Economic Forum)

Who is serious about it?

The Chinese and the Taiwanese. Because they measured return on invested capital, every semiconductor company in the U.S. except Intel decided to outsource their microchip production. All that production went to Taiwan. Morris Chang [who pioneered the $28 billion semiconductor foundry industry] now owns half the chip production in the world. When I asked him why he wanted chips on his balance sheet, he said, “Because I measure profitability in cash, not ratios.” I don’t see why American companies can’t think that way.

3 comments
jchyip
jchyip

From what I understand, Toyota, like most Japanese manufacturers, outsources a significant portion, that is, > 70%, which suggests that integration is more complicated than outsourced vs not outsourced.

TomPiper
TomPiper

One of the biggest problems, IMO, is insular institutionalized thinking. Too many of our business leaders come from a select few business schools. I could say the same thing about our government leaders as well.

DeweySayenoff
DeweySayenoff

It would have been much simpler to just say, "Money", and be done with it.  

This article is very insightful but says exactly that.  The focus of American businesses has always been on profitability first and everything else second - including sensibility and/or reason.  That exclusive focus on the bottom line creates a short-term mentality that can't see the road ahead, let alone respond to changing market conditions BEFORE they negatively impact the business.  Instead, American businesses run in pursuit of the Almighty Dollar around the sharp turns in the market and smack straight into fiscal crisis every damn time.

You'd think at some point someone would say "Hey, this is insane!"  There's a good reason no one does.  Well, not a GOOD reason, but a reason.  And it's a reason completely overlooked by the article.  

It's called fiduciary duty to investors.

When you have stock-holders suckling greedily at the bottom line demanding to be fed or they'll kick out anyone who slows the flow of profits to their pockets, you have a board focused on keeping their own butts in power and doing what is best for investors - not what's best for the company.  THAT is what accounts for the narrow focus on short-term profits and why so many companies see their CEO's coming and going faster than commuter trains at rush hour in times of economic hardship.

The funny thing is that going private saves the company because they then shift their focus from what's best for investors back to what's best for the company, where the focus should have always been in the first place.

NONE of this should come as a surprise to ANYONE.