During downturns, business leaders keep choosing to reduce spend rather than investing in innovation. It’s time to propose a more compelling alternative.
Marc Andreessen made waves earlier this year with his article “It’s time to build” — a manifesto decrying our collective failure of imagination and widespread inability to build in response to uncertainty. Whether or not you agree with his specific viewpoint, as the economic downturn resulting from COVID-19 continues months later, one thing is undeniable: large corporations are reducing their innovation budgets and we are watching whole industries stagnate.
This response is frustrating to innovation leaders, who have become increasingly astute about developing portfolio approaches to innovation. If business leaders continue to choose to make reductions rather than invest in innovation, perhaps innovation leaders must consider that their case itself is flawed. One innovation leader recently asked me:
“Corporate business leaders are smart, highly-experienced executives, so they’re not making investment choices lightly. Explain to me their logical argument, because I just don’t get why they don’t choose to invest in innovation.”
So what are innovation leaders missing?
As someone who has spent time in both innovation and business roles, I believe it is necessary to understand the logic and incentive structures that drive business leaders’ decisions in order to identify their fallacies and propose a more compelling vision of an alternative operating model for corporations.
1. Business leaders are incentivized for stability
For publicly-traded companies’ CEOs, investor reporting has been compared to a football coach who not only needs to call whether they’ll win or lose during the first quarter, but also by how many points. Earnings Per Share (EPS) has become the primary measure of success for public investors, which has forced the application of short-term business strategies.
In response to downturns, years of operators’ actions have led to the creation of the following playbook, which is sometimes known as the “Rings of Defense”:
- Reduce unnecessary expenses — consulting, travel, admin, etc.
- Slow new product delivery — R&D, innovation, etc.
- Reduce headcount
Why select this strategy? This model seems rational — it mimics personal budgeting — and it is predictable. Finance teams can model expected growth/decline rates and optimize for a predictable Earnings Per Share to appease public investors, whose capital they need during downturns. Traditional, publicly-traded competitors are likely to select similar strategies, so it is believed that the industry will slow as a whole and no one will gain competitive advantage during this period.
- Portfolio Theory would suggest that cutting underperforming businesses to enable investment in highly-performing businesses is a better strategy. Unfortunately, R&D and Innovation work often require years to bring to market and corporations often lack experience in growing new lines of business, making these endeavors difficult to model in their early years. Long-term innovation investments are comparatively devalued by FP&A (Financial Planning & Analysis) teams who rank investment opportunities based on expected ROI and margin accretion so that the CEO can signal to market that the business will continue to be profitable as it grows and scales.
- The “Innovator’s Dilemma” inhibits corporations’ ability to view moving downmarket into less profitable segments as desirable. As a result, corporations’ view of “competitors” often disregard or diminish the threat of new entrants or industry disruptors, which are incentivized to begin with these “undesirable” customers, take market share during a downturn, and are often private or venture-backed companies, which can grow unprofitably.
2. Business leaders are incentivized to make slow decisions
A McKinsey study demonstrates that leaders who rapidly divest during downturns and rapidly reinvest just before upswings generate more business value than those who do not.
Yet moving quickly is not in the nature of corporations. Corporate leaders have been fed a diet of “deliberate strategy” for years and thus crave enough data and analysis to make an informed decision.
Deliberate strategy is pervasive in management consulting: it clearly defines where the organization is now and where it wants to be in the future, then charts a clear path from one to the other, based on data and repeated leadership experience. Emergent strategy, by contrast, is deployed by many startups, whose future is relatively uncertain; leaders must rely on making constant inexpensive and deliberate experiments to convert assumptions into knowledge in order to rapidly “pivot” toward their ultimate goal.
Corporate organizations — their processes, people, and structures — are optimized to maintain their current path. When faced with uncertainty, corporations wait, seeking additional information in order to make the “best choice”.
Why select this strategy? It is inefficient to make and unmake choices in most large corporations. Changing directions creates confusion as corporate-wide messages are written and retracted, mid-level managers are forced to rewrite “waterfall” project plans, and employees are forced to rework deliverables or remake processes. As a result, corporate leaders are incentivized to make the “right call” every time.
- Many corporations’ decision-making processes are broken. In his 1997 shareholder letter, Jeff Bezos talks about “one-way vs. two-way door” decisions. He suggests that few decisions are irreversible (“one-way doors”); for those that are, deliberate strategy should be applied. For all others, he suggests that the benefits applying emergent strategy far outweigh the costs. Bezos cautions leaders not to confuse which type of decision they are making. While deliberate strategy certainly has its place in corporations, it is often misapplied to situations with unknown futures (such as downturns), causing leaders to wait for more data, which inevitably does not come or cannot come fast enough.
- Many corporations do not have a robust enough corporate strategy, which is required in order to rapidly execute divestitures, so downturns catch them off guard. In order to divest a line of business, a corporation must have a clear growth strategy, context on how that business fits into it, and critical “sign posts” for when they must alter their strategy. Even if their leaders rapidly decide to divest a line of business, the process of executing on this decision often takes corporate strategy and corporate development teams months to execute.
3. Business leaders are incentivized to avoid interpersonal conflict
Business leaders certainly have experience in delivering hard news over their careers. So why is it that when faced with the need to reduce headcount, business leaders often make broad, general cuts rather than targeted cuts related to business strategy?
Let’s face it: everybody wants to be liked. Business leaders will often self-rationalize that they are being considerate or fairer by taking a general approach to conflict rather than building a specific viewpoint, which may offend some people or favor some at the expense of others.
Why select this strategy? The word “politics” is commonly applied in corporate settings, which refers to the choice to operate in a way that cleaves to an individual leader’s personal preferences or style, even when it may not be the most efficient path for a specific initiative. To some extent, these choices are necessary. Much of the work within corporations is cross-functional, where a leader lacks the authority to independently make decisions, thus organizational change through influence can only be accomplished by the exchange of value. In short, business leaders must compromise on their decisions in order to retain the capital necessary to move their other initiatives forward.
- Making broad cuts across the business under-resources areas of the business poised for growth and over-resources areas that are stagnant. Ironically, business leaders’ attempts to not hurt one group specifically cause the entire organization pain. Under-resourced employees feel disempowered because they believe their leaders do not understand the criticality of their initiatives to the business, and overworked, which leads to burnout, further slowing these critical initiatives.
- The #1 job of the CEO is acquiring and deploying capital in the organization. In order to maintain a robust portfolio, CEOs cannot exclusively invest in their highest returning segments, however that is not an excuse to invest without strategy. When deploying capital, it is necessary to understand the nature of the business — is it a star, cash cow, growth engine, or pet — and match the investment to the business strategy. Furthermore, having a clear perspective of the future enables clarity of decision-making for which initiatives to invest in at the expense of others.
An alternative operating model
So what are business leaders to do in the face of an economic downturn and an uncertain recovery? I propose this alternative vision that accounts for these existing logical fallacies.
- Focus on growth over efficiency: Going into first-quarter 2020 earnings calls, Wall Street investors had already significantly discounted the stocks of most companies and the market was experiencing volatility. CEOs and CFOs felt compelled to provide guidance in the face of uncertainty, which did little to quell investors’ concerns. An alternative approach would have been to rescind guidance, articulate the key innovation drivers for the company, and share plans for investing capital into specific innovation priorities that executives had confidence would drive growth, based on market gaps they were seeing non-traditional competitors attempting to address.
- Rapidly develop a perspective and act decisively: Where would these investment dollars come from? Shutting down underperforming segments, divesting low-growth lines of business or slowing investment in cash cows. Business leaders mistakenly believe that selecting a specific strategy is “riskier” than doing nothing; however, doing nothing is itself a strategy… and one of the riskiest. Leaders with decisive mindsets are acutely aware of how various lines of business fit into their overall corporate strategy and have options already lined up to execute when specific conditions develop. People respect strong perspectives even if they disagree with them.
- Execute actions that produce data: How should business leaders develop a strategy in times of uncertainty? For a CEO focused on the efficient deployment of capital, the answer is easy: as inexpensively as possible. By launching multiple growth experiments simultaneously to test specific hypotheses, corporations can rapidly convert assumptions into knowledge. Data brings new perspective to difficult conversations: leaders can no longer argue based on their opinions when faced with the truth of customer insights. Organizations who embrace emergent strategy both understand the value of action and select rapid and dispassionate decision-making processes to enable execution.
At High Alpha Innovation, we partner with the world’s leading organizations to help them break out of these decision-loops by building in response to uncertainty. We believe in launching an ecosystem of startups targeting adjacent and transformational opportunities, so that as these startups scale, their learnings accrete back to the corporation to refine their understanding of markets, influence corporate strategy and possibly become acquisition targets.
Come build with us as we drive growth through tangible innovation!