Monday, January 28, 2008

Innovation Killers: How Financial Tools Destroy Your Capacity to Do New Things
by Clayton M. Christensen, Stephen P. Kaufman, and Willy C. Shih

This is a great article in the January 2008 edition of HBR (reprint R0801F) on the critical traps in deploying classic financial tools to innovation. One of the more provocative issues discussed is the assumption that if the business does nothing the current cash flows will remain. The flaw in this logic is the concept of “the fade” – if a business does nothing to support its position, the business quality will fade ~10% per year due to stronger competitors and/or stronger customers. Clayton Christensen relates this to classic DCF analyses in the following graph. I highly recommend ordering the reprint for the full article....

The DCF Trap
Most executives 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. For a better assessment of the innovation’s value, the comparison should be between its projected discounted cash flow and the more likely scenario of a decline in performance in the absence of innovation investment.


Bob Cooper said...

This article was circulated around my function (Finance) two weeks ago and it has gained serious traction. We were in the midst of gaining approval on three-year plans for the three divisions when the article began to circulate. Several GM's were told to re-think how they evaluated the "base business" before simply layering on the volume/top-line/cash flow benefits of innovation and new products. The conclusion was that supporting a brand and keeping the base "flat" is not as simple as maintaining marketing spending. Several business units ended up re-modeling their three-year plans and innovation-related projects were not always 100% incremental, but rather these projects helped to fight an acceptable fade with little overall incremental profit growth.

Gavin Daniels
Auto Care / Brita U.S. Planning & Analysis
(510) 271-2171

Bob Cooper said...

Looks like our timing was good for Fredrik Taube at Ericonson....

Hi Bob
Are u a mindreader??

just what I needed right now, to convince my Senior exec!!