In 1959, wracked by advanced syphilis and weighing just 80 pounds, the anorexic 74-year-old Isak Dinesen (Karen Blixen) electrified audiences at the Young Men’s Hebrew Association Poetry Center in New York with bravura recitations of some of her stories. A contemporary cartoon in The New York Times Book Review has one beatnik asking another, “Did you catch Isak Dinesen at the Y?” Those who saw the performances felt they had been privileged to connect with the “wise, noble, and heroic survivor of the past—the master—they had been expecting”.[1]
For those lucky enough to attend it, Accenture’s recent Innovation Conference in Johannesburg offered an equivalent opportunity to witness a very different kind of performance. A professor at the Harvard Business School, Clayton Christensen is recognised as a leading thinker on disruptive innovation. His analysis of the way in which new entrants into the lower end of the US steel market ultimately reshaped the industry remains a classic, and he has written widely on the subject; The Innovator’s Dilemma was named Best Business Book in 1997. (Visit Google to see his TED talk on disruptive innovation.) He was named the No. 1 Management Thinker in the world by Thinkers50 in 2011 and 2013.
Despite illness and a stroke, Professor Christensen demonstrated the power of clear thinking to shed light on a complex subject. In its own way, it was business’s version of “Isak Dinesen at the Y”.
Professor Christensen’s talk was focused on offering an explanation for why the American—and other—economies are failing to produce jobs. The phenomenon of jobless growth is something with which we in South Africa are sadly all too familiar. He argued that there has been a fundamental change in the way in which the US economy operates. This can be seen by looking at the nine recessions recorded since the end of World War II. The pattern for the first six was fairly constant: it took around six months after the economy bottomed out for companies to begin hiring again, and thus for prosperity to take hold.
The subsequent three recessions (1991-2, 2001-02 and 2007-08) show a very different pattern, with the interval between hitting bottom and beginning to hire again growing to 15 months, then 39 months and then a staggering 70 months for the 2007-08 recession.
The curse of jobless growth
It’s clearly a worrying phenomenon because it means, essentially, that economic growth is not being translated into prosperity. The results are playing out in an economy near you: in Greece, Russia and here in South Africa. We see them in the growing disconnect between the huge profits recorded by hedge funds and fund managers—hence Goldman Sachs’ being dubbed the “vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money”[2]—and the growing plight of the blue-collar workers and even the middle class.
Not to put too fine a point on it, it’s a scenario that breeds revolutions.
So why aren’t economies creating growth? The reason, Christensen believes, is that we are simply investing in the wrong sort of innovation. In his view, there are three types of innovation: market-creating, sustaining and efficiency. The last two are hugely important in order to make good products better (sustaining innovation) and to reduce costs (efficiency innovation), but they do not create jobs. In fact, efficiency cuts jobs.
“Nearly all growth is created by market-creating innovation,” he says. Examples would include South Korea’s Kia, Hyundai and Samsung which started with simple cheap products that opened up new markets, and required new manufacturing capability, creating more jobs and, incidentally, expanding the market for improved products—a true virtuous cycle.
For Samsung, it all began with an electric fan, an affordable piece of highly desirable technology in the sweltering humidity of a South Korean summer. Now it’s the electronics company to beat.
Investing for the long term
However, the challenge is that market-creating innovation is a long-term investment, whereas sustaining and efficiency innovation show quick returns. Now, here’s the really profound part of the analysis: thanks in part to the way business and finance are taught in the business schools, economists, analysts and businesspeople are taught to measure performance by using a set of ratios, chief among them return on net assets (RONA) and internal rate of return (IRR).
This, Christensen argues, means that the company’s performance is measured not as it once was by managers in whole units (how much was produced at what cost, and so on) but by the economist’s and analyst’s view which allows companies to be compared as short-term investments. CEOs are incentivised to produce good financial returns, so they focus on efficiency and sustaining innovation rather than market-creating innovation. Such investments produce free cash flow which should, ideally, be invested into market-creating innovation but, increasingly, simply go back into the other two types.
As a result, we are investing one-third of what we did in 1950s in market-creating innovation, Christensen says. For example, Japan, once the poster child of market-creating innovation—think Honda motorbikes, Sony electronics, Canon printers—began using ratio-based performance measurement in the 1980s and since then has come up with precisely one: the Wii.
Another consequence of this new economy of money investing in money rather than production, capital is no longer the scarce commodity it once was—there’s so much of it that we can actually waste it (hence the rise of crowd-sourcing) and the cost of capital is practically zero. In some countries, in fact, it has a negative value. That in turn means that central banks have virtually no powers to influence economies since mechanisms like raising interest rates are meaningless.
“We need to rethink finance in fundamental ways,” Christensen concludes.
It seems a reasonable inference that the current and escalating disparity in wealth as described by Thomas Piketty could, in great measure, be ascribed to this “ratio-based” style of investing. Money flows to investors (i.e. those who already have it), while the numbers of wage-earning jobs declines. Recent research shows that 0.1 percent of American families hold 22 percent of the nation’s wealth, almost the same percentage as that held by the bottom 90 percent—not quite as bad as it was in 1929, but close.[3] The drive to get America manufacturing again is a response to this state of affairs. Thus GE, arguably one of the US market’s bellwethers, is retooling to make stuff, rather than supply financial services. (In practice, market-creating innovation, it could be argued, goes hand in hand with manufacturing.)
The bad news for South Africa
Having put forward his theory, Christensen spent some time talking about its implications. We should take one observation to heart: countries blessed with abundant natural resources have found it impossible to share their wealth with the mass of their citizens. He cited Venezuela (tipped by some to be 2015’s worst-performing economy), Mexico and Nigeria—perhaps not including South Africa out of politeness to his hosts. Resource economies do not create widespread prosperity because, in Christensen’s terms, they are heavily focused on efficiency and thus on shedding jobs—something that the recent strike in the platinum industry will hasten.
Another point that for us to ponder. South Africa is the possessor of a highly sophisticated financial sector, one of the few areas in which we are world class—yet it is the fount of short-term, ratio-based investment. One could also add the fact that corporate South Africa seems to be sitting on a lot of cash—even though the exact extent of it and what it means could be argued several ways, there’s not much investment in market-creating innovation and thus in job creation.[4]
The figures say it all: according to Statistics South Africa, the manufacturing sector declined from 19 percent to 17 percent of the economy in 2012, while finance, real estate and business services—none of them creators of new markets or jobs—rose to 24 percent.
To conclude on a positive note, Christensen pointed out the huge opportunities that continue to exist for those companies and countries that are willing to look at patterns not of consumption but of non-consumption, because they show where innovations should be sought, where the pent-up demand actually is.
[1] To quote her biographer, Judith Thurman, in Isak Dinesen. The life of Karen Blixen (London, 1982), p 421.
[2] The quote comes from Matt Taibbi, “The great American bubble machine”, Rolling Stone 5 April 2010, available at http://www.rollingstone.com/politics/news/the-great-american-bubble-machine-20100405.
[3] Emmanuel Saez and Gabriel Zucman, NBER working paper 20625 cited in The Economist Espresso, Monday 22 December 2014.
[4] Cees Bruggemans and Hugo Pienaar, “Myths and misconceptions of SA’s corporate cash pile”, BDlive, 29 April 2013, available at http://www.bdlive.co.za/opinion/2013/04/29/myths-and-misconceptions-of-sas-corporate-cash-pile.
