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Capitalists Dilemma
View from a practitioner
Stone & Chalk is one of Asia’s largest startup innovation hubs, with over 95 full-time startups housing over 320 people with a partner base of over 25 large Australian and International corporate partners. The issues articulated in this article have perhaps never been so visible. Each day I am in front of boards and executive teams that despite knowing they are at risk of being, or already are being disrupted grapple with being able to allocate sufficient capital to invest in projects that might make a material impact the success of their businesses in the medium to long term.
The key points illustrated in the article still on solid footing and if anything I would imagine have been strongly validated in a post GFC world. Using fintech as a case study, since approx. 2006 it has secured over $100bn of investment, has spread globally and in many markets like Australia, Singapore and the UK, governments are now taking affirmative action to make regulatory and legislative changes in the areas of licencing, investment, open data to lower the barriers to entry for fintech companies.
Yet despite this banks all around the world have struggled to justify allocating sufficient amounts of capital towards truly transformative or Market Creating innovations.
It’s true that as the ratios and tools etc that the article points towards as the likely causes have and continue to be key contributors to the lack of investment in market creating innovations, but there are also several other factors that are perhaps just as big if not bigger in their contribution.
I think a lot more attention has to be paid to the shareholder and analyst contributions to the problem. Humans naturally want to be successful and decisions and behaviours are influenced by where these pressures are coming from.
Taking a 30,000 ft view on some of these:
1. Pension funds – what might be a very interesting topic of conversation is that for several decades now Australia has moved away from a defined pension scheme which guarantees a certain fixed pension for life to a contribution based model i.e. you get back what you put in plus the year-on-year accumulated growth at the time of retirement. In this market the pension funds have no funding gap beyond what they are measured by the same quarterly and annual performance indicators that analysts use for normal organisations. So as a result they also put pressure on their portfolio companies to keep providing combinations of share growth or dividend yields to increase fund performance over this time period.
2. The Analysts – a lot of the article if focussing on the tools that managers and corporations are using to make investment decisions but perhaps the biggest damage is resulting from the tools analysts are using to judge those companies on their performance. To a large extent analyst views are in todays’ public markets what is heavily driving non-strategic shareholder behaviour. So this leads me to think, is the article still asking the right question? Through this lens perhaps the answer is “no”.
3. Some of the ratios being used are backward looking; that is they are assessing performance of a previous period in time. Examples include RoA, ROI, ROE etc. Others are forward looking, NPV, IRR etc. One might say accounting versus finance ratios.
Today the metrics of R&D spend as a percentage of revenue is sometimes quoted, however this is a very blunt tool given the lack of transparency of what is actually included in the R&D spend.
However, what is missing is a tool set to give to analysts and shareholders that are meaningful leading indicators of overall organisational performance. A balanced scorecard if you will that includes a detailed “Innovation Index” of sorts.
Other important considerations:
4. Agency effect – product of incentives, performance measures and tenure
5. Types of capital – operational, incremental, growth, patient etc / Angel, VC, PE public markets
6. Role that uncertainty plays in the current tools as well as in existing and understood markets vs new and unexplored markets vs “timid and enterprise” from article
7. If capital is in oversupply then is Talent and the subsequent IP they create the new scarce resource? This leads to a whole new area of exploration.
Possible Solution
For example, let’s brake down the types of innovation and create a type of capital for each. The total R&D spend could be broken down in to the 3 types of innovation:
1. Performance Increasing
2. Efficiency
3. Market CreatingThen this would provide transparency on how much capital the organisation was placing in each area. This would then indicate to public markets whether the organisation was focussing their efforts and make it a lot easier for executives to communicate their strategies confirmed by their capital allocation and provide the transparency analysts need.
With a greater level of transparency, markets can better judge whether corporations are allocating capital to deliver on the strategic objectives as well as a benchmark against competitors.
A paradigm shift is occurring in what is the source of new competitive advantage
Building on point four above, given several conditions; technology increasing the rate of change exponentially, demand for talent outstripping talent supply. More and more younger people wanting to create their own startups exasperating the talent shortage.
I would argue through observation that organisations (even the likes of google etc) can no longer attract all of the world’s best talent in their relevant fields.
Paradigm shift is in how to innovate.
The 20th century model was “inside-out innovation” competing for talent, capital and remaining factors of production, building it internally and selling it in market.
The 21st century model is already becoming “outside-in” innovation. Facing the above realities, organisations are being forced to work with 3rd parties such as startups, scaleups etc to help them provide the products, services, capabilities etc they need to not only innovate but to remain relevant at the core of the business.
Therefore, if the logic holds the new source of competitive advantage is predicated on an organisations ability to attract the best partners in market to want to work with them as a first choice. Or in other words, the corporations that become “Go-To” for startups and scaleups will be the ones that attract the best in breed ahead of their competition and in so doing stand to gain a significant source of competitive advantage at a fraction of the time, cost and potentially risk of doing so internally.
This potentially leads us to the “4th metric” as a leading indicator of organisation performance.