Personal Finance

When is following good management principles bad?

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Quality management concept. FILE PHOTO | NMG

Summary

  • When personal computers [PC] came on the scene in the late 1980s DEC managers saw them as a hobbyist's toy.
  • As good management principles preach DEC managers choose to keep doing what they were good at.

When can worshiping at the altar of good management principles be a bad thing?

When it comes to the domain of innovation, the problem can arise when one is faced with a decision on whether to invest in disruptive technology. This is the innovator’s dilemma.

In 1995, Clayton Christensen introduced the theory of disruptive innovation. It was a real step forward seeking to address the question of why successful companies have such difficulty staying on the achievements trajectory.

And, why small start-ups on the periphery, focussing on what seemed like an unprofitable small inconsequential market, were able to move up the value chain, to challenge once-dominant incumbents, to become the market leaders.

This is reassuring news for the entrepreneurial Kenyan player, showing how by being small and affordable, and perhaps offering a product with lesser quality it is possible to grow.

Today the terms ‘disruption’ and ‘innovation’ are used quite loosely to try and support whatever it is that is on offer. The words ‘disruptive innovation’ are often applied in any situation, in a sector where there has been a shake-up, and the once successful market leaders stumbled. It helps to understand Christensen’s framework and the innovator’s dilemma to position what is, and what is not, a genuine innovation on the shop floor of the business.

Missing the boat

A classic example is the case of DEC – Digital Equipment Corporation that dominated the mainframe and minicomputer market from the 1960s and was eventually acquired, to become a shadow of its former self, as described in Christensen's landmark book, published in 1997.

When personal computers [PC] came on the scene in the late 1980s DEC managers saw them as a hobbyist's toy, after all that was what the Apple II was designed to be. Initial PC in the market was slow, it was often the case that fast typing, would overtake the processing speed of an Intel 286 chip. In addition, the initial applications were limited to, for instance, word processing and spreadsheets.

As good management principles preach DEC managers choose to keep doing what they were good at, selling more expensive mainframes to their large corporate and institutional customers aiming to increase their margins. After all, that is MBA business schools preach as doctrine: keep your customers happy and target increasing profitability.

What happened is almost ancient history, with the first personal computers [and now smart phones] dominating the world we live in and how we do business. Strange thing is, if anyone was ideally placed to take advantage of the new PC disruptive innovation, it was DEC and similar mainframe and minicomputer makers.

They had the knowledge, skills and technical resources to master the technology, but lacked the flexible adaptive mindset, to see personal computers as the way of the future. Same for Kodak who invented digital photography, but instead stuck to the business of conventional film processing, and did not see the opportunity in digital images, till it was too late.

So what is innovation?

To understand why this happens it helps to understand the three types of innovation: disruptive, sustaining, and efficiency.

Disruptive innovations -- often begin in markets, large corporate players choose to ignore. Disruptive innovations, in the beginning, tend to be simple and affordable, usually focusing on a tiny market, with often unattractive profit margins, offering a product that has room for an improvement in quality.

Sustaining innovations – are the normal improvements, any company acts on, just to stay competitive, making a good product better. Sustaining innovations don’t create much growth, and typically no additional jobs are created.

Efficiency innovations – aim to do ‘more with less’ cutting costs wherever possible, and usually eliminate jobs. On the finance dimension, they are stars, creating free cash flow. When an examination is done using financial ratio analysis, efficiency innovations come out tops on ROI, return on investment, ROCE – return on capital employed, and IRR – internal rate of return.

Now you see the problem. If you are the CFO of a large corporate, where would you invest, given shareholders want to see short-term returns on their investment?

Christensen makes the case that, for growth in jobs, and sustainable economic growth, one has to take the longer-term perspective and invest in disruptive innovations that Silicon Valley is famous for. And, closer to home, are right under our noses in the East African silicon savannah.

Disruptive innovations take place in markets that incumbents overlooked and start by appealing to low-end, underserved consumers and then gradually migrate to the mainstream market, with improved quality product offerings. In other words: they start simple, and then gradually improve.

Supporting disruptive innovation

While large corporates are masters of sustaining and efficient innovations, the chances of them coming up with disruptive innovations is close to nil. By definition, quirky disruptive innovations are born at the edge of the marketplace, on the untrodden path not usually taken.

An exception would be a company like Google that ranks its top 100 projects on a scale of 1 to 5 and has room on the list for ‘skunk works’ like initiatives that are described as ‘new and far out’ and allows staff a percentage of time to pursue disruptive technologies.

Only a company with deep pockets, or a particularly innovative 'open to possibility' mindset, with a way of managing resource allocation and risk, may be able to do this.

Christensen's advice to companies responding to disruption was to keep strengthening relationships with customers with investments in sustaining innovations. But when it comes to dealing with disruptive innovations, the suggestion is to create a separate unit, under the protection of senior leadership, apart from the core business to nurture the initiative.

When all is said and done, disruption theory does not explain everything about innovation, or business success, as there are far too many forces at play, but understanding it helps clear foggy thinking, providing a framework for clarity.

For the entrepreneur inventor of disruptive technology, life can be tough, despite the ecosystem of assistance, including incubation and accelerator programmes. But disruption theory shows how there is light at the end of the tunnel. It helps to remember that both Apple and Amazon started from humble circumstances in a garage.

Consider the thought of Jeff Bezos: “I think frugality drives innovation, just like other constraints do. One of the only ways to get out of a tight box is to invent your way out.”