The Blank Slate, Dominant Logic, and the Financialization of Corporate America
Startups have an incredibly high rate of failure. Over 90% fail to return capital to their investors, and more than 80% fail to meet their projections, according to an HBR professor Shikar Ghosh’s analysis of 2000+ companies.
We can now track failed investments in new companies via tools like CB Insights, Mattermark, write-downs from late stage funds like Fidelity, and the countless personal failure memoirs. Just last week, Shuddle, Kitchensurfing, and Dinner Lab shut down after each raising substantial rounds of investment.
But what do we really know about failure inside of big companies? The innovation failure rate is clocked at somewhere between 50 and 90%. (Andrew and Sirkin, 2003; Cierpicki et al., 2000; Sivadas and Dwyer, 2000). But these failure rates tend to only include fully commercialized products, not including those that were shelved prior to launch, or even prior to the first experiment.
Whereas startups need to overcome resistance to change among their customers, corporate innovators make a career out of tackling resistance to change from all sides - internal management, shareholders, and customers.
I would wager that there is one major strategic advantage that startups hold against big companies: the blank slate. You see a problem, and you develop a solution to that problem, and you’re off to the races. You build your business model on top of a blank slate. Sure. you have to get customers interested in making a change. If you’ve tapped a huge growth opportunity, you can get investors on your side.
Corporate innovators face a mountainous and often treacherous topography when proposing new ideas in the form and shape of dominant logic thinking, and the financialization of public companies.
The dominant logic of senior executives, and the conscious and unconscious mental maps developed through the experience in the original core business, are often applied inappropriately to new businesses. Dominant Logic was a theory explored by management thinker C.K. Prahalad who studied the success and failure of conglomerate structures in the 1980s. He determined that dominant logic favors the core business at the expense of the new.
The resistance to change is not just internal. Large public companies have been more inclined to benefit shareholders than to invest in innovation. According to a Goldman Sachs analysis by Chief Equity Strategist David Kostin, $1 trillion of the $2.2 trillion planned investments in 2016 by the S&P 500 firms will go to share buybacks and dividends. Only $650 billion will be invested in capital expenditures, or investments in larger scale innovation efforts and R&D, a 1 % increase over 2015.
What does this mean?
Say you are the CEO of a large public company. You are evaluating the innovation portfolio in your investment steering committee, and decide that you’ll give the go-ahead to keep investing in core and incremental innovation. You also evaluating a number of investments in radical innovation - your team has proposed a number of opportunities in emerging technology arenas and a few acquisitions as well. But you’re worried about your company's technical capabilities. Could we spend the money efficiently? If we do make an acquisition of a high flying tech startup, would the value truly increase after the acquisition?
More often than not, CEOs and investment steering committees are choosing to postpone bets on radical internal innovation. They consider such investments too risky, and decide that the money is best returned to shareholders.
While critics have said that this kind of financialization of corporate America a short-term method to boost profits, the trend still continues in the favor of share buybacks and dividends over increased investment. According to The Wall Street Journal, BlackRock’s CEO Larry Fink wrote, “more and more corporate leaders” are taking “actions that can deliver immediate returns to shareholders, such as buybacks or dividend increases, while underinvesting in innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth.”
What does this mean for you? Starting a startup is hard, but innovating inside of Corporate America is getting even harder.
So is there hope for the innovation optimist?
There are companies that have broken free from dominant logic and been able to commit to continuous business model innovation. They do tend to be agile in their thinking, therefore adaptive to change:
- Adobe: shifting to subscription and cloud-based services and expanding their market size in the process
- Google: transforming the corporate structure to Alpha-beta and separating their “other bets” from their main source of cash growth
- Netflix: shifting to streaming services and original content in order to increase the value of their subscription service
- Facebook: moving to a mobile-based model after being ridiculed for seemingly expensive acquisitions like Instagram and WhatsApp (which now seem like the best performing acquisitions in the history of M&A)
- Amazon: growing a massive cloud services business out of Amazon Web Service (AWS) while also creating competitive moats through Prime Subscription and other business model innovations
To be sure, these companies have software at their core, and data as the primary value driver in their business model. With the exception of Adobe, most of these companies are not even 20 years old yet, and therefore are not encumbered with the barnacles of industrial age dominant logic thinking.
Each one of these companies proactive intentional “creative destruction” a concept introduced by Austrian-born American economist and political scientist Joseph Schumpeter.
“The opening up of new markets, foreign or domestic, and the organizational development from the craft shop to such concerns as US Steel illustrate the same process of industrial mutation - if I may use that biological term - that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating the new one. This process of Creative Destruction is the essential fact about capitalism.” - Joseph Schumpeter
As a political scientist, Schumpeter was encouraging nations to open up and accept the benefits and drawbacks of creative destruction, rather than try to prop up sagging companies and industries, while trying to protect jobs, leads to stagnation and decline.
Much of Schumpeter’s argument seems to be at the root of major political disagreements in the US, Europe, and around the world. But the real beneficiaries are companies that practice creative destruction.
The agile, growth-oriented companies seem to be taking Schumpeter’s philosophy to heart. Their greatest strategic weapon may not be a weapon at all, but a mindset. These companies commit to a beginner's mind, to not accepting that the current competitive position and business model as a sure thing. While they keep their future cash flows protected, they approach new opportunities with an awareness that dominant logic thinking may be their ultimate downfall.
So it’s not really a question of startups vs. corporates, but a battle between leadership that fears change, and leadership that seeks opportunity in change. Who are you as a leader, and are you in an environment where you can seize an opportunity?
