Accounting for Managers: Interpreting Accounting Information for Decision-Making, Canadian Edition

READING 5

Innovation Killers: How Financial Tools Destroy Your Capacity to Do New Things

by Clayton M. Christensen, Stephen P. Kaufman, and Willy C. Shih

For years we've been puzzling about why so many smart, hardworking managers in well-run companies find it impossible to innovate successfully. Our investigations have uncovered a number of culprits, which we've discussed in earlier books and articles. These include paying too much attention to the company's most profitable customers (thereby leaving less-demanding customers at risk) and creating new products that don't help customers do the jobs they want to do. Now we'd like to name the misguided application of three financial-analysis tools as an accomplice in the conspiracy against successful innovation. We allege crimes against these suspects:

• The use of discounted cash flow (DCF) and net present value (NPV) to evaluate investment opportunities causes managers to underestimate the real returns and benefits of proceeding with investments in innovation.
• The way that fixed and sunk costs are considered when evaluating future investments confers an unfair advantage on challengers and shackles incumbent firms that attempt to respond to an attack.
• The emphasis on earnings per share as the primary driver of share price and hence of shareholder value creation, to the exclusion of almost everything else, diverts resources away from investments whose payoff lies beyond the immediate horizon.

These are not bad tools and concepts, we ...