Wednesday, November 12, 2014

Clayton Christensen: Do We Need A Revolution In Management?

"Do we need a revolution?" ask Clayton Christensen and Derek van Bever in the June 2014 Harvard Business Review (HBR). "The orthodoxies governing finance are so entrenched that we almost need a modern-day Martin Luther to articulate the need for change."

When "the world's most influential business thinker" calls for a revolution, maybe we should pay attention. The "revolution", says the article, would have three parts. (1) "New ways to assess investments in innovation… (2) We should no longer husband capital. It is abundant and cheap… and (3) …new tools for managing the resources that are scarce and costly."

One immediate question: is the needed revolution about acquiring new tools or new management mindsets? New tools applied with existing mindsets risk leading to more of the same. In fact, could applying new mindsets to the existing tools go a long way to the revolution that the HBR article is talking about?

June 2014 HBR: Are Investors Bad For Business?

Christensen's article is one of a trio of articles in the June 2014 HBR that examine whether capitalism is on the right track, under the banner, "Are Investors Bad For Business." I will discuss each of the articles in separate reviews, starting with the article by Clayton Christensen and Derek van Bever, "The Capitalist's Dilemma."

In part one of the review last week, I explored the idea that managers were excessively using ROA and ROIC. In this article, the second part of the review, I examine how some existing tools might be used better.

The deeper question is: should managers be pointing a finger at investors and blaming them for the ills of the economy? Or should they rather be looking in the mirror and examining whether their own management practices, attitudes and values are the root cause?

Doing IRR right

"Over and over," the Christensen article says, "the higher value placed on ROA, IRR and earnings per share over other metrics has led to innovations that squeeze costs and noncash assets. As a result, investing to create growth and jobs is a third-best option, behind efficiency innovations (first) and doing nothing (second)."

In big corporations, the use of the the internal return (IRR) has led to market-creating investments suffering in comparison with cost-saving investments. But why? Is it the tools or the mindsets of the people using the tools?

Thus let's take the example that Christensen frequently uses to demonstrate disruption—the case of Dell. Some years ago, Dell began outsourcing manufacturing to a Taiwanese electronics manufacturer, ASUSTek. The outsourcing started with simple circuit boards, then the motherboard, then the assembly of the computer, then the management of the supply chain and finally the design of the entire computer. Using IRR and ROA analyses, this sequence supposedly "made sense" because Dell's revenues were unaffected and its profits improved significantly. The end result? ASUSTeK became Dell's formidable competitor, while Dell itself, apart from its brand, was hardly more than a shell, without any real expertise to run or grow its business.

"Bingo. One company gone, another has taken its place." The implication is that the IRR and ROA "made Dell do it." It made "perfect sense" for Dell, on the basis of those ratios, to outsource until it suddenly found had no expertise left.

"There's no stupidity in the story," wrote Christensen. But is that really true?

So far as we know, the decision-making at Dell didn't include:

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