1. Evaluate the Argument of the “Capitalist’s Dilemma” Article

In your view, where is The Capitalist’s Dilemma article on solid footing and where is it less compelling?

For those who participated last time, has your view changed since two years ago?

Previous Submission 2. Do We Have a…

27 thoughts on “1. Evaluate the Argument of the “Capitalist’s Dilemma” Article

  1. In an ideal scenario for this dilemma, we have loyal shareholders with a long time horizon investing in risky potential MCIs that could lead to growth. However, would the large companies know what to do with additional capital if it was available, less timid, and less migratory? Is there enough R&D in the pipeline with these companies to trigger growth?
    If companies were to double down on their R&D investment, and even categorize their projects by innovation types in order to allocate the right resources at the right times, it could still take 10+ years for the innovations to form, fail, reform, succeed, and lead to growth. Patience cannot be the only factor to consider – what are the others and could any of them accelerate progress?

  2. Will more capital matter if individuals and groups don’t dream big? Our greatest pioneers are working on reusable rockets and same-day delivery services. Great stuff, but I want my warp drive and teleporter.

    1. I think the article’s point is that it doesn’t matter if there’s more capital, and that even with so much surplus money, companies are not allocating those funds to invest in the right kind of innovation (i.e. the kind that results in warp drives and teleporters). The big question then is: how do you get individuals and groups to dream big? If they do already dream big, how do you get rid of whatever obstacles are stopping them from executing on those dreams?

  3. I found quite similar arguments between the Capitalists Dilema Article and the introduction to “The Balanced Scorecard” by Robert Kaplan and David Norton(year 1996).
    The following is my opinion and personal perspective:
    The fact that companies are sitting on a big pile of money has two probable effects, 1)they have a feel for financial safety so the urge to go out to the wild and fight for survival does not exists. 2)this inexistent urge puts companies in a comfortable mindset from which they can be more “observers” and less “doers”. It is part of human nature to fight back only under pressure and is under pressure when we are the most innovative, creative and are more willing to risk. Risk and hard times are great motivators.

    I also believe that a probable cause for the Capitalists Dilema is the way that companies measure success, more specifically, that companies measure success from a financial perspective only, which narrows down the “success topic” to cold numbers. For example:
    *Actions that focus on short term results to increase stocks prices.
    *Actions that focus on easy-to-messure outcomes(quantitative data) instead of qualitative success.
    *Companies are evaluated on monthly, quarterly or yearly performance, so prioritization of such goals are preferred.(Yet no “Empire” was build in such a short period)

    Because many executives have come to strong and well stablished companies, many might not know how such a company got where it is right now, and that is, probably having taken big risks and betting for uncertainty in their early years. In my opinion, the Capitalist Dilema is based on risk-taking adversity, not trusting the guts to pursue greatness and in general staying stagnant and confortable.

    I do agree with the notion about companies being less and less prompted

  4. It also seems like there’s a widely held belief that CUSTOMERS, like CAPITAL, are scarce. This mindset may not be true, and it seems like it could also lead managers to avoid game-changing, market-creating innovations. A little bit of jobs-based thinking could help break this down.

    Marketers talk regularly about metrics like share of market and share of wallet. Many companies are even valued based on the number of subscribers or “eyeballs” they attract. These metrics are loved by managers who define markets based on product categories and customer demographics, rather than jobs. But these false fences built to define markets can easily lead one to believe the total pie is relatively fixed, leaving large incumbents no hope but to protect their current customers or squeeze as much money out of them as possible. The idea of bringing in millions of new market participants seems unfathomable.

    But in reality, we may be living a world where there is actually an unprecedented abundance of untapped customers who are not currently defined as “in the market,” simply because they have not transacted within the perimeter of the markets we’ve defined in the past. Those untapped customers may, however, be ready to transact now, and companies may be able to provide them with products or services at a cost below a market-clearing price. Managers just don’t see them or overlook them because they define the market based on who spent money on the products that existed in the past. With technologies enabling lower-cost innovations, internet access helping more people “go to markets”, and emerging economies continuing to develop, there may be a global “customer superabundance.” Managers’ attention to metrics that help them manage scarce customer bases may blind them to all the people who could POSSIBLY be in the market. As a result, they are left to fight vigorously over the finite people who are ALREADY in the market.

    1. Good point, Adam. Clay Christensen refers to the the customers the incumbents have overlooked as “non-consumers” or the non-consumption segment of the market. Most incumbents continually invest upmarket, but ignore the non-consumers they have already excluded. That’s often a huge segment of the population. Low-end disruption and new market-creation occurs when innovators target non-consumption. Suddenly the population that was too low-end to have access to the incumbents’ products, is given access with products that are “good-enough” for them to get the job they need to be done, done. Time and again we see this phenomenon of disruption via exploitation of non-consumption.

  5. I wonder if managers often don’t feel as if they have the agency to take sufficient risks with investors’ capital. Incentives are tied to one / two year paybacks, while the risk of disruption is a multi year (albeit massive) cost – comparing the two is neither intuitive or an easy excercise.

    1. I think that’s certainly a substantial part of the reason, Ishan. Investing in disruptive innovation doesn’t cater to the risk-averse. CEOs and managers who aggressively pursue disruptive innovation often have the trust of their investors to do so, or don’t pander to investor sentiments. Of course much of that may have to do with a proven success rate. Amazon’s shareholders and investors seem to readily defer to Jeff Bezos’s long-term directional decisions because it’s been a winning formula. I think that’s why Question 3 asks “How Much Should Companies Focus on Quarterly Earnings vs. Long-Term Growth?” isn’t an intuitively easy one to answer.

      1. Thanks for the response Farsh. That actually spurred another thought, I wonder if companies fit into certain archetypes in terms of why they do not invest in long-term growth. You mentioned companies that are beholden to their shareholders.

        Perhaps another archetype would be companies that are beholden to their engineers:
        I recently talked with a manager at an aerospace company that described a process of innovation focused on new engineering solutions. As an internal R&D process, that is not an issue. However, they applied the same logic when acquiring new start-ups, their acquisitions were largely based on resources. Almost never did they consider new business model innovations (processes, priorities, and profit formulas). This is happening in a world with vastly publicized disruption, with companies like SpaceX and Blue Origin. This type of issue is embedded deep within a company’s processes, and as a result, their culture. The culture is sustained by management who are promoted from engineering departments. I imagine that enacting change would require strong leadership tools and power tools, which perhaps is only possible through hiring new management.

        This comment perhaps is better suited in 7. Is it Hard for Companies to invest in Market Creating Innovations?

        1. I definitely agree with you on this, Ishan. The embedded and sustained culture is certainly an influential aspect of the investment decision making process. It seems sensible that managers would pursue sectors with which they’re familiar and follow the “stick with what you know” dictum. And often the companies we tend to think of as innovative are tech-heavy (Amazon, Google) and therefore culturally and logistically set up for diversified R&D. I would probably think it questionable if the top management of a well-known candy company suddenly started heavily investing in R&D for self-driving cars. So perhaps, yet another archetype is sector? Are MCI’s largely sector specific?

          1. I think the BSSE theory would posit that when MCIs start they would need to be interdependent solutions, since they likely won’t achieve a customer’s definition of good-enough. As an extension of that theory, some MCIs may need to be cross-sector. Self-driving automotives built by technology companies could be an example of one.

            I’m still thinking about how this fits into the overall story, but perhaps this is a useful anecdote:

            For a CFO class last semester we had the CFO of Google X, Helen Riley, as a guest. She works alongside Astro Teller, the lead of the division. One consistent theme and challenge that came up, was how does one budget for a division like Google X, which works on things as diverse as Google glass, global internet access, and self-driving cars?

            The first layer of her response was that both Larry Page and Sergey Brin were super passionate about the work. They devoted substantial money and time to Google X. Both leaders have visions about the jobs to be done 20 or 30 years from now, and they build products around these jobs.

            The second layer was that Helen and Astro would often talk in a very transparent way. Their focus was on frugality, and in particular, seeking the minimum cost required to conduct the next incremental experiment. If that minimum cost was too great, they would try to split the experiment to again minimize cost. If they weren’t able to split the cost, they would cease to proceed with the experiment. One example of this was with weather balloons used to deliver internet access. At some point the costs of the experiment exceeded an internal cost threshold, and they decided to cease work until they found another way to experiment. This is perhaps a slightly different take on the notion of being impatient for profitability.

            Lastly, they equipped their team with eclectic and diverse talents. This was clearly to promote contrarian and innovative thinking. However, perhaps it’s a bit lacking when compared to true heavyweight teams. My sense was that the teams lacked experience with running profitable P&Ls, and were better at inventions.

  6. And if I may add an addendum to this thought, I think the power of self-selecting into an archetype can be a motivating exercise, largely because it involves both recognition of a problem and self-reflection. In addition, different archetypes may have different solutions. The challenge with this is achieving a set of archetypes that are mutually exclusive and collectively exhaustive.

  7. I wonder if this is a resource allocation process problem and RPP applied at a much larger scale – i.e. the capital markets or the capitalist society at large – could provide some insights. That we have focused on harvesting scientific breakthroughs of the past and not kept up with societal MCI of new scientific advances. I have not done the due research to back this up, but share the sentiment with Peter Thiel: that we have seen a burst of one-to-n breakthroughs and not enough zero-to-one’s.

    The Capitalist’s Dilemma article highlights enabling technology as a key ingredient of MCI. What if we haven’t been as productive in developing new enabling technologies as in ages past? And why? As a society, I argue we have more resources (population, talent, capital, energy etc.) than ever. But what are the dominant processes and priorities in the society of today? Are the processes and our culture prioritizing scientific advancement, or is wealth the least common denominator of a yardstick of progress and success? Is our education system as a process – the article highlights business school’s contributions – gearing graduates (investors, managers, scientists, politicians) for performance improving innovations or MCI? If they are incompatible, theory would point to heavy-weight teams to alter the processes or autonomous organizations with disparate priorities/culture. Are these solutions possible at a societal or market scale?

    At an individual level, what profit formulas are talents using to evaluate the investment of their resources (time, labor, skills) when making career or field of study decisions? And are these congruent with enabling conditions for MCIs? If we are only counting on billionaires willing to shun short-termism of today’s investors to make big bets on MCIs, we are severely underutilizing the resources, both capital and otherwise, of today’s society. The article focuses on the role of the financial sectors and the causal mechanisms there are convincing. But how about other societal processes (e.g. education sector, scientific communities)?

    1. I would argue that the education sector’s contribution to the problem is as large as the role of the financial sector’s short-termism. In the resource allocation process chain, the managers and decision-makers are ill-equipped to deal with the dilemma of taking a short-term hit to foster MCI vs. reaping short-term gains through performance-improving or efficiency innovation. These managers are likely ill-equipped because (1) they haven’t had the chance to learn how to navigate these processes in any “school of experience”; and (2) business schools separate strategy and finance, and rarely offer courses on cross-functional decision-making.

  8. There are two reasons why business leaders are driven to efficiency, or incremental innovations over market creating, or visionary innovations: 1. A side effect of Globalization: new markets have opened up thanks to globalization and small tweaks in products to satisfy regional preferences have allowed companies to get away from market creating innovations. In the past, a German company for example had a finite market: Germany, maybe extending into Western Europe. So once their market was saturated with current product, they needed to innovate a new product for their finite market. With globalization and the continual graduation of third world countries into emerging markets, existing products can be tweaked and sold to new customers. Once the global market is saturated, which has not yet happened for most products, companies will once again have to create new markets through innovation 2. Consumers are willing to pay for efficiency innovations. As long as we are forming lines to buy iPhones with efficiency innovations like wireless earbuds or higher resolution camera capabilities, Apple will continue to invest in those relatively minor tweaks.

    1. I agree — one of the many reasons companies aren’t pursuing market-creating innovations is probably because their customers aren’t demanding them. Classic example of how listening to the customer can actually be a hindrance for innovative progress. I would add though that maybe the customers aren’t demanding MCIs because they don’t know that they want it until it exists?

      On globalization as a driving force against the case for MCIs, I think these guys would would agree with you:
      – Peter Thiel: “1-to-n” companies that simply take what exists and sell them broadly across the world
      – The authors of “The Innovation Illusion”: Globalization involved two phases: (1) horizontal expansion of big firms, which pursued new markets with the same products; (2) vertical restructuring of value chains, to absorb and make use of the comparative advantages of different geographic locations. Global companies also put up higher barriers to entry, to protect themselves from radical innovation contesting markets.

  9. In terms of why capital is not being invested, one reason I don’t think you have given enough real estate to is Regulatory and Tax Policy issues. Before selling off GE Capital, GE had to have a certain amount of Capital on hand to satisfy the Fed’s Stress Testing regulations. This was not a GE Capital problem, it was a GE problem and kept a good deal of capital that could have been invested on the sideline. The tax regime in the US is also an issue and impacts investment.

  10. The focus on shorter term returns instead of longer term investment is probably partially caused by the shift (in the 80’s) to more active instead of passive investing – 401k’s vs. Pensions. People have a closer eye on their investments, want to see the lever moving whereas pensions of the past were managed more passively. You trusted your company to manage your retirement. Longer life expectancy also makes it more important to actively manage your investments.

    1. Do you think that pension plans of today have also fallen into short-term investing? I also wonder if individual investing in 401k’s counts as active investment — most people tend to just select an index to purchase.

  11. Some comments on renewing the system:
    While the Tobin tax idea is a good one, to me it is not something that is likely to happen
    L-Shares also a good idea but tough to implement especially in large firms. And would it move the needle at a place like GE? Not sure it would. Would be great to see an IPO that clearly stated they were going to use L Shares to reward long term investors and support market creating innovation.

  12. While I agree that market creating innovations create jobs, many of the market creating innovations today – Advanced and Additive manufacturing, robotics, AR/VR – are birthing a gap in that job creation. Current jobs are being eliminated by technology, and the skills sets needed for the new jobs that are being created are not ones enough of the current workforce are trained with.

  13. While I agree that the article is written in a compelling way, some sections are lot more compelling than others. In other words, some dimensions are in solid footing compared to other sections that are less compelling.

    To get my point across, how about I identify my findings on the following two dimensions.

    1) Root Causes dimension
    2) Solutions dimension

    1) Root causes dimension

    While I agree with the root cause for the Capitalists Dilemma (the way companies measure success using capital efficiency), it might be helpful to dive deeper and point out out the assumptions behind it as well.

    1. Capital in this case is primarily financial capital only
    2. Financial capital is most scarce and costly resource of economic activity(which is not true any more based on Bain research)

    With that as prelude, the article in my opinion stands on a SOLID FOOTING when building the compelling case for the following root cause:

    With the fact financial capital is no longer the scarce and costly resource (based on Bain research) the implication is that the efficiency of financial capital is not the right way to measure economic success.

    That said, the article in my opinion, is LESS COMPELLING, when it makes the following generic assumption

    – Capital is primarily financial capital when it comes to the economic value creation process.

    Which then begs the following question

    What is the economic value?

    This is where, some of the work done by our firm might be helpful and so, if it is OK with you all, let me build a case using our firm’s Virtual Ocean Strategy (VOS) framework (https://www.linkedin.com/pulse/how-does-vos-solve-21st-centurys-1-economic-dilemma-three-prabakar).

    First things first –

    Economic value in our mind is a composite capital that starts as the human capital (which is an intangible/infinite/virtual resource) transforms itself into P&S capital (after mixing with physical resources) with the primary job of meeting the needs and wants of customers (which is customer or jobs-to-be-done capital) before being transacted as financial capital, with purpose capital in the middle orchestrating this cycle ” — and then the cycle continues, when financial capital is reinvested.

    However, the challenge here is that human capital that starts with the infinite potential, in most cases, gets lost and do not transform itself into financial capital, during this cyclical value creation process.

    Some of the root causes for this value leakage include, but not limited to are

    1.1. Capitalistic systems today are designed with bulk of its weight to financial capital driven value, as opposed to giving the situational weight for all of its five capitals (purpose, human, P&S, customer and financial capitals).

    1.2. There is no standardized mechanism to measure human capital (or productivity in macro economic terms), similar to how we measure financial capital (capital efficiency ratio ROIC or in a larger sense the Zen of Corporate fiance formula) with a causal linkage between them. For example, human capital today is mostly measured in companies based on opinions of few people from calibration sessions(which is highly subjective).

    1.3. Unlike financial capital(that is measured based on future projected cash flow within DCF(which is nothing but financial capital potential), human capital predominately is measured by performance alone (which again is based on a opinion and not based on human capital potential)

    1.4. There is no well established causal linkage between financial capital and human capital.

    1.5. Talent management (source for human capital potential) system and Performance management systems (source for human capital performance) in most companies are not well integrated. In other words, potential and performance, the two sides of the same coin called human capital, is not integrated.

    1.6. The subtle nuances within what we call upper case TALENT which is a combination of skills, talents and gifts are not well understood by the line leaders in most companies. For example, we as a firm classify skills as learned (e.g driving a car)whereas and lower case talent is something that comes naturally to someone(e.g. composing music effortlessly, public speaking etc.). On the other hand, gift is usually rare and it is given from higher power above(Intuition, leadership reach, wisdom etc.).

    1.7. Under the current economic value creation model, the assumption that physical resources are available in plenty may not be true in all countries(e.g. Sand as pointed by this article). However, sand is a scarce resource in some countries. Similarly, if we take Cement, the amount of cement consumed by China in the last 10 years is equivalent to that of US in 100 years. An Implication is, let’s say, if all of the developing world, start consuming resources like the developed world, say in 25-50+ years, there will not be enough physical resources in our planet to maintain the same life style.

    1.8. Yet another challenge is within P&S capital (including intermediate P&S capital) which is primarily measured using inventory turnover ratios, which does not make sense (like ROIC) due to three shifts (linear economic model to circular, sequential value flow among five capitals to criss-cross value flow among these capitals, static portfolio to dynamic portfolio driving production closer to consumption).

    1.9. While Customer capital is governed by jobs to be done theory, which is primarily needs focused, there is another part to the customer capital called experience to be enjoyed(which is wants based and it is not well measured). The wants or experience part of the customer capital is putting tremendous strain on this economic value cycle, especially in the last 10 years thanks to advances in digital/data/design driven experiences.

    1.10. Last but not the least, there is no well established causal link providing framework that ensures there is a causal linkage among these five capitals, starting from purpose capital (vision + mission + values + codes+ BHAG) that sources the economic activity of a firm, as attempted by ourn Virtual Ocean Framework (VOS)

    2) Solution dimension

    We suggest adding three more solutions to the already well thought out 4 solutions

    2.1. Augment the three types of innovations outlined in this article as a 10 types of innovation so that leaders can apply the right type of innovation to the right situation depending upon where the value is stationed and/or flowing within the value cycle.

    What do I mean?
    As we look at these 10 root causes, one thing for sure is these root causes are multi disciplinary in nature and this is the reason we as a firm decided to take an integrated approach, while developing our framework, by integrating the top 3 discipline pairs(leadership/culture pair, strategy/finance pair and innovation/marketing pair) with a following hypothesis.

    – Strategy/Finance pair is a value creator, Innovation/Marketing is a value accelerator, while leadership/culture pair is an value enabler/orchestrator — and so, it is important that organizations take this integrated view, while creating/accelerating value.

    Within the context of this hypothesis, accelerating value (or performance) is all about innovation — and so, it is important that we understand the differences between the 10 different types of innovations depending upon the location of value within its cyclical flow (whether it is temporarily stationed on a value station or in transit between value stations)

    For example ,

    – When the value is temporarily stationed on human capital the dilemma leaders face is bottom line driving operation innovation or top line driving growth innovation.

    – When the value is temporarily stationed on customer capital the dilemma leaders face is customer centric innovation or vision innovation. General guideline here is, when it comes to needs based P&S, customer centric is a way to go and when it comes to wants, vision centric is a way to go.

    -When the value is temporarily stationed on P&S capital the dilemma leaders face is market driven innovation or resource driven innovation.

    -When the value is temporarily stationed on financial capital the dilemma leaders face is Profit innovation or purpose growth innovation.

    – When the value is anchored on Purpose capital the dilemma leaders face is vision/mission driven or values/code driven innovation.

    Similarly, when the value is in transit, it goes through five innovations (elegant, efficiency, effective, boundary less purpose and resource innovation) as summarized in this article (https://www.linkedin.com/pulse/how-virtual-ocean-strategys-capitalismvizplanet-solve-prabakar)

    2.2 Within this larger VOS Umbrella, we are currently in the process of developing another sub framework within (VOS) to measure human capital, to measure human capital accurately
    As alluded earlier, according to our worldview framework called MBA, we view human capital as energy (like quantum energy) and it manifests as motivational heartbeat(sourced by gifts/talent) and belief driven mindset(sourced by skills ) — and they merge/balance before manifesting as Actions, as explained in the sidebar of this article(https://www.linkedin.com/pulse/economys-invisible-handsame-our-creators-handwa-wo-charles-prabakar)

    More specifically,

    We assign a maximum of 10 units to mindset energy in TIME dimension as follows. However, in real world there are so many time wasting distractions and so,

    Actual Productive mindset energy of an individual = 10 – organizational TIME or leadership drag and could vary from 1 to 10. On an average it could be 2.

    Similarly, we assign a maximum of 10 units to heartbeat energy in SPACE dimension. However, in real world there are so many political/environmental distractions and so,

    Actual Productive heartbeat energy of an individual = 10 – organizational SPACE drag or culture drag. It varies from 1 to 10 as well. So, on an average it could be 2

    Similarly,
    Productivity of an individual within a team and organization = (Actual Heart beat Energy + Actual Mindset Energy) x Individual Leadership/Culture x Team leadership/Culture x Team’s balanced competition/collaboration drive x Organizational leadership/culture x Organization’s balanced competition/collaborative drive — where we assign maximum of 10 units for each

    Now applying this formula to say an individual from a standard team
    Productivity of an average individual from an average team and average organization = (8+8) x 8 x 8 x 8 x 8 x 8 = 524,288 HC units

    Now applying this formula to say an elite individual from a world class team from a world class organization

    Productivity of an elite individual from a world class team and organization = (10+10) x 10 x 10 x 10 x 10 x 10 = 2,000,000 HC units

    An implication here is, maximizing individual leadership/culture, team leadership/culture and organization leadership/culture, along with a healthy balance of collaborative/competitive spirit can improve the productivity of an individual by a factor of approximately 5x.

    Similarly, we can also create country/global productivity of individuals at the macro economy level, by adding individual productivity of individuals, and then create a causal/correlation linkage to GDP, which by the way is a key theme behind our VOS driven VizPlanet platform, where we have developed a novel approach to democratize the elite human capital as explained in this VOS article article(https://www.linkedin.com/pulse/how-does-vos-solve-21st-centurys-1-economic-dilemma-three-prabakar).

    2.3 . Trade human capitals like financial capital with a mantra that every person is a P&L producing entity as explained in this article (http://www.managementexchange.com/hack/reforming-performance-management-systems-%E2%80%93-virtual-purpose-equity-vizpity%C2%A9-exchange-way).

    While we have not ironed out all the details yet, as a first step, we are exploring ways to trade companies on two capitals out of the five (current market price along with an equivalent cumulative human capital value that caused that financial value), so that investors can have full visibility of the causal linkage between them at any point in time, I am currently in the process of tweaking it, however, you can get the larger idea by reading this earlier version of the article.

  14. Schumpeter’s Comments on “Capitalist’s Dilemma.”

    Abstract
    The relationship between the types of innovation and the job increase should be carefully verified. Ratio still does matter in the micro-level capitalists. I propose four suggestions to avoid Capitalist’s Dilemma.  1) Separate managers and capitalists completely. 2) Managers become capitalists. 3) Increase the number of “silent capitalists.” 4) Enlighten the capitalists.

    1. On the assumption that the market-creating innovation create a lot of jobs but the performance-improving innovations create fewer jobs

    Even the performance-improving (sustaining) innovations may create a lot of jobs. 

    For example, Toyota is now making Lexus. To do so, Toyota or their suppliers need to hire craftsmen to equip hand-stitched leather seats, lacquer finished wood panels on their Lexus cars. Rolls-Royce needs to hire metal polishing craftsmen to finish the radiator-grills of their cars to upgrade their cars. 

    Swiss watchmakers hire more people by upgrading their watches from quartz-driven Swatch, which is made by robots mostly, to hand-made mechanical watches. (Since this example might not fit the definition of performance-improving innovation, but they are surly going upward in the watch market.)

    I think the question whether an innovator hires a craftsman or a robot, is answered not by the type of innovation (market-creating, efficiency, or performance-improving) they are going to pursue, but by the relative productivity between the craftsman and the robot, which is calculated by the comparison between the wage and the interest (=cost on capital goods, like robots). Since the interest rate is historically low in these days, we can hire more robots very cheaply.

    From the macroeconomic viewpoint, even market-creating innovations may decrease jobs. For example, eBay, categorized as a new market disruption in your book “Innovators’ Solution,” surely created a new market for person-to-person auctions.

    But, a father purchased a used toy for his son by using eBay, will not go to the nearby Toys”R”Us to purchase a new toy. Since the income is limited for every people in the short run, most market-creating innovations would reduce the demand for the goods and service supplied by incumbent firms, and therefore decrease jobs working in the incumbent firms.

    2. Ratio does matter.

    You insist that the capital is cheap and not scarce anymore. From macroeconomic viewpoint, you may be right.

    But as the micro-level capitalist, say your grandmother investing her scarce pension, the return on capital does matter. So, the question is how to maximize long-term return on investment despite the big asymmetry of information between the capitalists and the innovators.

    3. Suggestions to avoid Capitalist’s Dilemma 

    The main cause for Capitalist’s Dilemma is the difference between the capitalists and the innovators in the confidence in the profitability of the future innovation of different types. This is old and new phenomena. In the 19th Century, there was a conflicting view on the future of electric lighting between the innovator, Thomas A. Edison, and the capitalist, J. P. Morgan. Edison saw a clear future vision on electric light bulb and insisted in investing in the new factory and making lightbulbs in mass production. On the other hand, the capitalist, J. P. Morgan refused to invest more capital until the current investment is payed off by the income. Edison became furious and put his own money into the factory.

    To reduce the Capitalist’s Dilemma, I propose following four solutions.

    1) Separate managers and capitalists completely

    This approach is already conducted by Google, issuing special stocks. The shareholders having these special stocks have the right to get dividends but they are not allowed to intervene into the management decisions. By issuing special stocks, Google got a perfect freedom to innovate. 

    2) Managers become capitalists

    Why does the future vision of innovation by the capitalists and the innovators differ? Because they have different bodies. If we could make innovators be capitalist as well, this would solve the Capitalist’s Dilemma.

    “A joint-stock company” was a novel idea to collect scarce capital and put it into a new venture. But in these days, the side effect “capitalists’ myopia” is prevailing. 

    Modern innovative managers can also be capitalists by management buy outs (MBOs) and put the capital into the market-creating innovations. 

    In Japan there are many long-living companies surviving through harsh economic waves for more than 100 years. 90% of them are NOT joint-stock public company. The oldest company in Japan, which in fact is the world’s oldest, is Kongo-gumi, a construction company founded in 6th Century, lasting more than 1200 years. Most of the century-living companies are family-owned or unlisted, owned by a few “visible” capitalists’ hand. The capitalist-manager’s interest is not to make the company grow rapidly but to make it survive for many centuries as a family heritage.

    Therefore, making a joint-stock public company into unlisted or privately owned, managers will be able to pour the entire capital into the market-crating, disruptive and long-term innovation.

    3) Increase the number of “silent capitalists” 

    As is clearly written in the best-selling book “A Random Walk Down Wall Street” by Burton G. Malkiel, just buying the whole stock listed in a certain market according to each company’s market capitalization, you can beat most of active fund managers or, in our words, professional capitalists, who evaluate the firms’ future value, speculate the best timing to buy or sell stocks and trade frequently. 

    In 2014, one-third of the capital held by individuals and professionals (in the U.S. I assume) is invested in passive index funds.

    In Japan, Government Pension Investment Fund invests 35% of its134 trillion-yen ($1.2 trillion) asset into the world’s stock market, and more than 80% of its stock market investment, which is about 37 trillion yen ($ 0.3trillion) is poured into passive index funds. 

    Having these silent capitalists as their shareholder, managers would feel less tension toward myopic, short-term, efficiency or upgrading innovation.

     
    4) Enlighten the capitalists

    WR Herbrecht, a venture capital in San Francisco, is not using RONA, ROCE, IRR, for their investment decision. Instead, they invest in disruptive firms using their pattern recognition capability. Their performance is superb.

    If more and more capitalists learn Prof. Christensen’s theory on innovation, and begin investing their capital more wisely, then market creating innovation would be fostered and flourish.

    Hoping this little article help you somehow,

    Schumpeter Tamada, Ph.D.
    Professor, Institute of Business and Accounting, Kwansei Gakuin University

    1. Re: your point on increasing the number of “silent capitalists” — don’t you think that allowing passive index funds to have so much power could cause shareholders to no longer feel a sense of ownership? In your discussion of making managers become capitalists (i.e. having them feel a sense of ownership and responsibility over the company’s future), you talked about unlisted or family-run companies being better at focusing on the long term, due perhaps to their concerns of their legacy. But if more people buy into passive index funds, we would run into the agency problem: Vanguard, for example, may not have its objectives/goals aligned with those of the people who’ve bought Vanguard funds.

  15. 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 Creating

    Then 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.

  16. I’ve mostly been commenting on healthcare MCIs, but just read a newly published article from a former professor of mine who studies the political economy of Germany. His piece has fascinating overlap with the Capitalist’s Dilemma in that it clarifies the risks of a capital-hoarding nation (like Germany) to both the domestic and international liberal economic order. Well-worth studying: http://www.transatlanticacademy.org/publications/surplus-germany . I am happy to connect you with him; his input would be invaluable.

  17. Most of these comments are on a macro level, but have you noticed that a single individual can either 1) Augment public opinion; or 2) their actions can erode a brand’s capital like a virus.

    Recent examples: 1) Donald Trump or Brexit; 2) Unethical behaviour of Uber employees

    So when we talk about influencing macro strategy, it’s the micro behaviour that nudges trends into the right direction.
    I believe that people are the “product”, trust is our “currency”, and relationships are our “capital”.

    If we use an analogy which shifts towards the “uber-isation” of individuals, who are empowered with the option of their own data ownership, then we have immense opportunity to nudge trends with behavioural economics.

    There is a movement which encourages consumers to create their own value exchange proposition by enabling them to utilise their own data, ID and preferences as assets when engaging with trusted brands.

    I believe in transparency for the “right” reasons, and “smart” consumers will be eligible for benefits and rewards based on their influence capital. This micro-segment of society are fulfilled by co-creating delightful experiences with the products they choose to engage with.

    As technology continues to automate tedious processes, people are learning the art of communication, by design. In order to grow sustainably, a humanised, digital experience builds brand capital, and growth with a meaningful and scalable, value exchange.

    Dan Ariely’s Social enterprise, Lemonade is an insurance product (I love a good oxymoron!) and is capitalising on transparency and reciprocity. The company is collecting data and developing insight stories which validates behavioural economics.

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