“Necessity, who is the mother of invention.”
(Plato, The Republic, 347 B.C.)
“Cash flow is the father.”
(Roger More, 2009)
“The idea is to get more cash out than we put in.”
(Tony Soprano, The Sopranos TV Series, 2008)
“Innovation is the process of change that creates and grows wealth.”
(Roger More, 2010)
It appears that innovation means at least several things to different people – any new product or service, value creation or a particular “culture of innovation.” But these and many other “interpretations” of innovation are meaningless, as this author contends. In fact the only thing that matters is whether an innovation creates wealth. And the only metric for determining that wealth is net cash flow. As he writes, “If an innovation is pumping real positive net cash flow over time, all of the other assorted financial metrics will be just fine! If it is losing cash flow, the other metrics don’t matter!”
Over the past decade, there has been a continuous and voluminous global outpouring of government concerns, media reports, corporate comments, and business school writing and research on the critical need for more “innovation” at every level of corporate and government management. Inadequate funding and the lack of a commitment by corporations and governments to “innovation” have been cited as major causes of different countries’ “non-competiveness” on the global stage. The subliminal premise and presumption behind much of the writing is that “innovation” is always needed, always useful, always positive, and always a good allocation of scarce cash and human resources. For many people, it has literally come to be seen as its own objective; doing more “innovation” of all kinds and committing more and more cash and human resources are always productive and always effective uses of these scarce resources.
This paper will argue that much of the current writing, research, conceptualization, and perspectives on innovation are shrouded in a series of dysfunctional, hopelessly complex, irrelevant, non-measurable academic theories, myths, ambiguities, half-truths, and fuzzy thinking that defeat innovation’s usefulness to real-world professional managers. These are the managers who have to decide which specific technological and other innovations to develop, adopt, bundle and integrate into their competitive market strategies, and to which ones they should commit real cash and human resources.
This paper will also argue that the primal objective of innovation must be to create and grow real wealth, which is the long-term, net cash flows of companies that develop, apply and bundle technological and other innovations with the products and services they take to competitive global markets. It is critical to put this hard cash flow metric of success on “innovation”, and to conceptualize it as a tough set of specific, well-defined strategic choices for professional managers. It is also critical that we stop considering innovation as a universally desirable human trait of “leadership”, or a set of corporate and management activities, or a cultural dimension of people and organizations.
Without this hard cash flow metric , “innovation” and much of the writing and research on it degenerates into a vague, mythical and largely useless organizational cliché like many others, including “leadership” ,”sustainable development”, “environmentally friendly”, “socially responsible”, “social capital” and a host of similarly fuzzy homilies with little or no strategic or managerial substance in reality, no shared concept or connotation, and no metrics to determine their utility and value.
This paper will also argue that there is no shortage of technological or other “innovations” in most companies; nor any shortage of new ideas for new technologies, products, services, or processes for creating and delivering them. There is, however, a desperate shortage of successful innovations, namely those that can create and grow wealth. Many examples can be cited of “innovations” that were exciting but that also wound up losing huge amounts of cash. This paper will argue that the major problem with innovation is not insufficient cash flow into innovation; it is insufficient cash flow out! Corporations and governments fund too many losers!
Business schools bear a unique and special responsibility for these innovation scenarios. They are the organizations that are at the core of the development, teaching, writing and research on professional management, in both business and government. Given the staggering amounts of cash that will be spent by corporations and governments in the future on technological and other innovations, the role of professional management becomes paramount.
The critical core and essence of professional management is the complex organizational realities facing managers making the difficult strategic choices for scarce cash and human resources in companies. Innovation represents one of the most complex and difficult management processes for strategic choice. It is the clear responsibility of business school research to create new concepts and tools to help managers in the processes of making these choices in specific real-world innovation situations.
Innovation: The management challenge
No matter what your view or perspective is on the meaning of “innovation,” including technological innovation, there is little doubt that over the next fifty years, if you measure the relative importance of the corporate and government cash and human resources that will be committed to different strategic decisions globally, innovation, especially technological, will be by far the largest expenditure. It will also the most critical strategic competitive factor in global business.
Over the past decade, there has been a continuous outpouring of government concerns, media reports, corporate comments, and business school writing and research on the critical needs for innovation at every level of corporate and government management. The cry that “our country doesn’t do enough innovation to compete globally” is becoming a familiar mantra in Canada and many other countries. “We have to spend more on innovation”. In many countries, a plethora of new government programs are constantly coming up and mutating, often confusing, conflicting, and hopelessly administratively complex and inefficient. Entire office buildings are filled with government bureaucrats running these programs.
At this point, there is yet another wave of Canadian federal government concern and massive additional funding for more “innovation”. A recent article in MacLean’s magazine illustrates this. (1).”Nuclear industry gets big boost.” The article goes on to say that the throne speech specifically promised to bolster science and technology spending in order to “fuel the ingenuity of Canada’s best and brightest and bring innovative products to market.”
A number of quotes from the ongoing wave of concern about innovation are worth noting;
- “Innovation is the route to economic growth. Innovation is the creation and transformation of new knowledge into new products, processes or services that meet market needs. As such, innovation creates new businesses and is the fundamental source of growth in business and industry “ (2)
- “A report from the OECD says that in future Germany should develop more innovation in it’s domestic market” (3)
- “Canada is poor in creating innovation, and other OECD countries outperform us; we rank 14th among OECD countries. R and D financing by the Canadian private sector remains considerably below the OECD average .In terms of business investing, Canada ranks 15th.” (4)
- “The Science, Technology, and Innovation Council state of the union report confirms Canada’s underperformance in innovation. Data indicates that our nation suffers from low business R and D” (5)
- “It’s beginning to look like bad news for the innovative edge the United States has long enjoyed. From 1995 through 2001, China, South Korea, and Taiwan increased gross R&D spending by about 140 percent, while the U.S. increased its investment by only 34 percent” (6)
From these notes, and many more, it is clear that innovation is seen as playing a central and leading role in economic success in many countries. It is also clear that the funding and effectiveness of innovation is a widely-shared topic of deep and major concern in most if not all countries.
What is equally clear is that, in too many of these situations, the conceptual meaning of “what innovation is” and “what success means” is shrouded in complete ambiguity and confusion, and seen differently by almost everyone you ask. Until these questions are clarified, billions upon billions of dollars will be invested globally by companies and governments, frequently with no impact, or worse, result in huge and untracked cash losses.
Innovation: The management realities
It may be a painful reality but the fact is that real innovation can only be created by managers in companies competing in global product, services, and processes marketplaces. In viewing the management of innovation in these companies, it is critical to get close to the real world competitive realities facing these professional managers.
It is important to understand the tough realities they face and the competitive and strategic context for specific innovation decisions. Too often these decisions are looked at in isolation, as though they can be analyzed, interpreted and decided outside the context of the complex competitive global situation the managers and the company are facing. Some of the major factors characterizing and influencing this particular management reality are the following;
- Individual product and services innovations seldom add any value in isolation; they must be integrated and physically “bundled” with a wide range of other physical and process technologies to be applied. This presents great potential risk, since a particular innovation can appear to create competitive value by itself, but may not be compatible with the physical and process infrastructure in which it must be embedded. As an example, Intel may come up with a computer microprocessor innovation, but it may be too fast for the other components in a particular notebook to run with.(“You don’t put a Ferrari engine in a dump truck.”)
- A huge range of internal and external factors affect the success and failure of any innovation. Innovations can have interesting and positive characteristics in and of themselves, but in a real competitive situation there are hundreds if not thousands of internal and external factors, many outside the control of the management team involved, that will affect the success or failure of an innovation.
- What this means is that any innovation, if it is to hope to be successful, has got to have a huge advantages and offer competitive differentiation against the existing and competing “bundled” customer solutions.
- In addition to all of these challenges and difficulties managing the innovation-development processes in companies, there is an equally complex set of customer and market network-adoption processes to manage. When adopting a particular technological innovation, organizations can take a long time to go through a very complex adoption processes. In many cases adoption is very slow, making the imperative to develop companies’ cash flows even more intense.
- In the midst of all these factors that can affect the success or failure of an innovation, specific decisions are made by managers. These decisions involve conceptual, organizational and analytic processes of enormous ambiguity and complexity. Different parts of the organization may be involved, different functional managers, different geographic areas, and different manufacturing plants. There are a lot of decisions that have to be made that affect each other, and there is certainly an element of chaos.
- Different managers and organizational processes have different cultures, different personalities, different power systems, different reward and compensation systems for the success of innovation, however it’s viewed.
- At the real level of market competition, where innovations ultimately have to make their impact, and in specific product/service/market segments, every competitive and market situation is largely unique. There are no simple or general solutions. A particular innovation might be successful in one market, in one segment, in one geography, and fail miserably in another. There are no boilerplate solutions; no two competitive strategies are the same. A winning innovation for one company can be a losing innovation for another. So, an innovation is not in and of itself good or bad, it depends totally on the unique and complex DNA of the company and the specific competitive situation.
- Another huge complexity with innovation and all professional management decisions is that the evidence is clear that faced with a particular strategic situation in all its complexity, any two different teams of managers will see different factors as key and will make different strategic choices. A particular innovation will be viewed differently individually and by any group of managers who are looking at it. This has huge consequences for choosing innovations that can be successful versus innovations that are clearly sure to fail. Individual managers and those in a group will see it quite differently. And a fantastic innovation from the viewpoint of one group will be seen as a potential disaster from another group’s perspective.
- There is no way to predict the success of any innovation before its introduction. This begs the question of what makes an innovation a success.
- Every competitive strategy, every marketing strategy, and every innovation has the possibility of failure. There are numerous examples of innovations that started out with great potential and wound up as dismal failures. So at the very best, innovation is partly a “crap shoot.” It’s an issue of the probabilities of success; there is no way of viewing any innovation as an absolutely sure thing to succeed.
What is innovation?
Clearly, the word “innovation” represents a complex “construct,” a concept of wide and divergent dimensionality and conceptualization. Virtually every literature, writer, and manager has a different view of how to conceptualize “what it means,” and what dimensions and processes define it. In itself, this is a major methodological challenge.
The following is a brief sampling of some of the wide variety of concepts that would tell us what “innovation” is;
- “Innovation is the production or adoption, assimilation, and exploitation of a value-added novelty in economic and social spheres renewal and enlargement of products, services, and markets; development of new methods of production; and establishment of new management systems. It is both a process and an outcome.” (8)
- “Innovation is reflected in novel outputs: a new method of production, a new market, a new source of supply, or a new organizational structure, which can be summarized as doing things differently.” (9)
- “Innovation is a new way of doing something, or new stuff that is made useful.” (10)
- “Innovation occurs when someone uses an invention or an idea to change how the world works, how people organize themselves, or how they conduct their lives.” (11)
- “Innovation is generally understood as the successful introduction of a new thing or method. Innovation is the embodiment, combination, or synthesis of knowledge in original, relevant, valued new products, processes, or services.” (12)
- “Innovation is a new element introduced in the network which changes, even if momentarily, the cost of transactions between at least two actors, elements, or nodes, in the network.” (13)
The above sampling represents only a few of literally thousands of disparate, vaguely defined, confusing and clearly non-measurable concepts of innovation. In itself, this plethora of vague concepts represents a major block to any attempt to study and manage innovation.
But it is much worse than that. Governments all over the world are throwing billions of dollars at “innovation” programs and incentives , with no coherent or shared concept of what it is or how success in innovation can be measured. As a result, many government programs have become completely politicized, much more about political optics than reality.
What is success in innovation?
The question of what success means in innovation is one of enormous complexity. Suffice it to say that there are as many concepts and definitions of success as there are government agencies and managers in the global universe of competing companies. Many measures of the successful innovations seen in management and research literature are simply not measurable. And therein lays a major problem. We have a whole range of soft and loose measures for determining successful innovation. Many of these measures have been used widely in government funding of innovation, and frequently without any concern for what they mean conceptually or with any means of actually measuring them. Some examples of commonly seen “success concepts” are:
- Market introduction
- Bundling or integration into a product or service
- Export to some market
- Purchase by a particular customer
- Generation of some revenue dollars
- A successful application of the technology in the sense that it physically works
- Formation of a “company” based on the innovation
- Value- creation
Value -creation occupies a special place in this list of potential “success” metrics. To be successful, an innovation must clearly create differentiated value for the sets of buyers involved. However, the problem is that creating value for customers can cause or be accompanied by huge cash losses for the company involved. According to this definition, the majority of Nortel’s innovations created value – while the company went bankrupt.
There are many more of these “success” concepts. These diverse, often-conflicting, and mostly non-measurable concepts present major barriers to any notion of the coherent professional management of innovation. Worse, every one of the above concepts can be presented as a success, while the venture suffers huge, real cash flow losses.
The critical question of measurable objectives
The objectives for any innovation must be measurable. Objectives that are not measurable are just so much “fluff” and completely useless to managers in any situation. Many of the above innovation objectives are just that, such as “commercialization”, “market introduction”, “export to a global market”, and so on. But equally dangerous are measurable objectives that are misleading or downright irrelevant, such as revenue, market share, and others.
A new concept: Innovation as wealth creation and growth
I believe that the only useful and valid definition of innovation is the following one: “Innovation is the process of change that creates and grows wealth.”
By this concept, the artificial separation of “what innovation is” and “the objectives of innovation” is eliminated, and the primal purpose and success metric of innovation to create wealth is clearly established.
An excellent exemplar of conceptualizing innovation clearly as wealth and cash flow creation is General Electric, one of the leading-edge companies in embracing net cash flow creation and growth as the primary driver of overall financial performance, and the whole range of other financial metrics. In outlining the GE concept of breakthrough projects, one writer notes that ” breakthrough projects are planned undertakings aimed at achieving tangible, bottom-line (net cash flow) results in a short period of time.”(14)
It follows that if business school research is to help managers, the primary research focus must be on management process research that provides real-world tools and concepts that managers can apply in managing different stages and parts of the innovation process for specific innovation opportunities.
Understanding real wealth creation: Cash flow – earn vs. burn
Historically, many different, misleading and conflicting financial measures of wealth creation have been observed and applied. These include:
In many cases, these metrics can indicate financial “success,” even though net cash flows are negative! An obvious example is revenue (an innovation can generate high revenue in dollars per year, yet lose huge amounts of net cash flow!) There are many other examples.
This paper strongly suggests that the most useful and realistic financial metric for wealth creation is net cash flow. Wide and credible recognition of the centrality of net cash flow as the ultimate real metric of financial success and disastrous failure has been slow in coming. Such recognition has also been hastened by the recent debacles in the banking and investment community, General Motors, and Nortel, not to mention WorldCom. To put it simply, if an innovation is pumping real positive net cash flow over time, all of the other assorted financial metrics will be just fine! If it is losing cash flow, the other metrics don’t matter!
Linking innovation to net cash flow: The critical drivers
Once you have a clear set of cash flow metrics, they can be connected to the drivers of net cash flow for product and service innovations. A primal and simplified concept of cash flow creation is shown below. Over the time horizon of the innovation, the forces of negative cash flows (fixed costs and investments) must be overcome by the forces of positive cash flow (revenues x margins) to create positive net cash flows (NCF). In simplified conceptual summary:
- POSITIVE CASH FLOWS, $/YEAR (“CASH EARN”) = REVENUE ($/YEAR) X PERCENT MARGIN (%)
- NEGATIVE CASH FLOWS,$/YEAR (“CASH BURN”) = FIXED COSTS ($/YEAR) + INVESTMENTS COSTS ($/YEAR)
- NET CASH FLOWS (NCF, $/YEAR) = POSITIVE CASH FLOWS – NEGATIVE CASH FLOWS = CASH EARN – CASH BURN
If these cash flows are well and brutally estimated before any cash is committed to an innovation, and tracked and estimated during the process, analyzed as they unfold, and tracked after market introduction and buyer adoption, they are cruel and unyielding; you can’t make a “loser” look like a “winner”.
The need for accounting and finance cash flow tracking
Sadly, the fields of accounting and financial analysis are just today waking up to the realities of cash flow tracking, often replacing it with a bewildering array of complex, confusing, contradictory, and often misleading financial metrics. Recent experience has shown that the bankruptcies of GM, Nortel, Lehman Brothers and others were finally signalled by largely unseen, unmeasured, untracked, unexpected, unpredicted and catastrophic cash flow losses.
The most unbelievable aspect of these similar cases is the fact that, while these losses were occurring, each of these companies had hundreds of MBAs from the finest business schools in senior finance and accounting roles! The simple fact is that, in many of these cases, these managers were tracking the wrong financial metrics, as this paper has previously noted. As a result of these disasters, a quiet revolution in finance and accounting is gaining steam to focus on cash flow tracking.
Tracking innovation process cash flows: The critical dimension
“The idea is to get more cash out than we put in.”
(Tony Soprano, the Sopranos TV Series, 2008)
The brutal reality of cash flows for the innovation process is that the negative cash flows (“cash burn”) come first (investments and fixed costs), and the positive cash flows (“cash earn”) come later. Here, the crude wisdom of Tony Soprano and his mobster colleagues shines: Over the time span of the entire innovation process, you have to “earn” more cash than you “burn.” It is conceptually childishly simple, yet it seems to elude many managers, financial analysts, accountants, bankers, and government staff who should know better.
As a result, there are many examples of innovations that “burned” so much cash that it was mathematically impossible for them to ever “earn” enough cash to create any net cash flow! Why were they not stopped? A spectacular example is the case of General Motors’ Saturn.
Over the span of its development and market life, Saturn lost at least $11 billion of cash flow. Careful examination of this case shows that, early in its development, it became clear that there was no mathematical way Saturn could ever produce positive net cash flow. In the project, the early investment and fixed costs commitments (cash burn) were so high that there was no mathematical chance of ever overcoming them with positive cash flow (cash earn). As the market entry and plans for adoption proceed, the cash flow dynamic takes over and reacts to the strategy and all the strategic changes managers make.
Two innovation failures
It is not difficult to find examples of innovation failures. Each product or service innovation will be briefly described primarily on the characteristics outlined earlier, that predictably drive it into high negative net cash flow or make it highly inferior in net cash flow to competing solutions to the problems.
The need for more KWH of electrical power globally is growing and serious. In the face of this, there are a range of power generation sources, depending on location and the unique country situation. The innovation of wind turbines has been widely touted as a strong, “green” renewable electric energy source. However, careful analysis reveals that turbines are hugely inferior in wealth creation and cash flow terms compared to nuclear power plants.
Positive cash flows
- The amount of money paid by household and business power users in $ per MWH (megawatt-hour) has tended to be somewhat stable and low. They have been driven by the historical large-scale “conventional “power plants, long-term government debt amortization supported by long power plant life-cycles, and the roles of government power monopolies and regulation. It is unlikely that household and business power users will be willing to pay a multiple of today’s $/MWH, so any real cash losses will show up somewhere as taxation or government subsidies.
- Because of their intermittent operation (wind does not always blow), wind turbines need power backup from some other sources (example of another source) to sustain the needs of the electrical power grid.
Negative cash flows
- Investments per MWH of power are far higher for wind power than for nuclear energy, and other power sources.
- Operating fixed costs per MWH are far higher for wind power than for nuclear energy, especially when you analyze the realities of up-time and actual power outputs of existing wind turbines.
- A recent article by Schleede (15) highlights in detail the extreme inefficiency and high investment and operating costs of wind turbines when compared to other alternative energy sources.
- Another article by Will (16) outlines the incredible cash flow inefficiency of wind turbine power compared to nuclear power. Will notes that “America, which pioneered nuclear power, is squandering cash on wind power, which provides 1.3 percent of the nations’ electricity: it is slurping up $30 Billion of tax breaks and other subsidies amounting to $18.82 per MWH, 25 times as much as the combined subsidies for all other forms of electricity production.” He goes on to note that, “To produce 20 percent of America’s power by wind would require 186,000 tall (40 stories tall) turbines, and occupy land area the size of West Virginia. The same power could be produced by four nuclear plants occupying four square miles of land.”
What all this means is that the positive cash flows per MWH from both wind and nuclear power from the sale of MWH are about the same, but wind turbines use far higher negative cash flows per MWH to generate the power. Compared to nuclear power, wind power is an innovation failure.
General Motors Volt electric/gas hybrid car
The excitement around the innovation of alternative energy cars, and particularly “electric” cars, is well known. Faced with its imminent collapse, General Motors is introducing the innovation of the Chevy Volt electric/gas hybrid car. Again as above, a cursory analysis of the underlying cash flow fundamentals reveals huge, likely long-term net cash flow losses from this innovation:
Positive cash flows
- From a competitive point of view, Volt is not an electric car, such as the Nissan Leaf, and other emerging products. It really competes with gas/electric and diesel/electric alternatives, of which there are many on the market already.
- Revenues will likely be very low, with likely very low unit sales, with very high Volt prices, limited range, a small market segment for ultra-high gas mileage “green” cars, and successful existing and proven competitive cars at much lower prices and proven reliability (Toyota Prius, Honda Insight, Honda Civic hybrid, Ford Fusion hybrid and others).
- Margins will likely be slim and possibly negative, with very high variable production costs compared to likely car prices. A key component of these high variable production costs will be the batteries, which have proven to be a major problem for GM.
- Positive cash flows will therefore be very low, if there is any at all. If margins turn negative, potential positive cash flow also turns negative. If this occurs, the whole Volt innovation will suffer even greater cash losses.
Negative cash flows
- Investments will likely be very high, with new motive technologies never tried before, and extremely high and uncertain battery technologies and costs.
- Fixed costs will likely be high, with limited cross-vehicle scale economies and sharing with other cars in the General Motors portfolio. Also, GM seems determined to build its own battery production plants.
The critical importance of stopping innovation losers
One of the major problems facing managers and companies in their innovation processes is recognizing and trying to stop the negative cash flows going into losers that once looked like winners. Two examples were cited earlier. Sadly, there are many more.
The Chevy Volt project is a dangerous example. By General Motors’ own account, the car will likely suffer major negative cash losses for at least a few years for the reasons cited above. The risk here is that, in the future, many more competitors will enter the electric car market, notably from China and South Korea. These companies have already proven their ability to compete with high quality, low-priced, high- customer-value cars already, such as Hyundai and Kia. They will be formidable competitors in the electric car market segment. So why not stop the Chevy Volt innovation and go back to the drawing board?