The Capitalist’s Dilemma – Clayton Christensen

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Who believes in indefinite growth on a physical finite planet is either mad or an an economist. We dont want to focus politics on the notion that involves the of principles around. Which a large majority of our fellow citizens or bergen.
Actually live. We are not as endlessly manipulable and as predictable. As you would think.
The mckinsey global institute. Did a study where they identified in america. There had been nine recession since world war.
Two so the economy hit bottom and then rebounded to hit the prior peak. Economically and then theres always a lag between when the economy and the the economics of the recovery hit the prior peak and then theres a lag for when the employment hits that prior peak and as you can see here for the first six of the nine recessions it took about six months on average to get to the prior employment peak. But we had a recession in the early 90s where it took our economy.
Fifteen months to get to the employment peak and then in 2001 2002. It took us thirty nine months to get to the prior peak. And when they did the study.
We didnt know the answer in the current recovery and we still dont know the answer because in america. Hits. Taken us 70 months and were still nowhere near the prior peak of employment and there clearly is something thats gone wrong in our economy.
We have as weve described their jobless. Recoveries and that that wasnt the case twenty and thirty years ago. And so this is my sense for whats going on there are three types of innovations in the world.
And the reason why in my puzzling of this question. Im focusing on innovation is innovation is the target of investment. An investment is the fuel that keeps the economy going in one way or another.
So the first type of investment. We call an empowering innovation and what we mean by an empowering innovation is it transforms products that are simple and affordable from things that previously were complicated and expensive and youll see here that i i have three concentric circles. And what theyre made to represent as centermost circle.
Those are customers in a market that have the most money and then as you come to larger circles. They represent larger populations of people who have less money and less skill and a good example of this kind of empowering innovation. Would be the mainframe computer.
The mainframes cost two million dollars. Not very many people could have a computer and then the personal computer reduced the cost from two million to two thousand dollars. And so most of us could own and use a computer.
And now this smartphone for 200. Enables billions of people around the world to have a computer in a similar way when the automobile was developed originally they were a toy of the rich. But henry ford in the model t made a car so affordable and accessible that millions and millions of people can have it from our study.
I will assert that nearly all of the jobs in an economy are created by empowering innovations and the reason is is very simple if you make it affordable and accessible more people buy them more people use them. If you have to hire people to make them and distribute them and sell them and service them. And so on empowering innovations use capital because anytime you start a new business.
You need capital on the balance sheet. But this is the first type of innovation for the purpose of the issue tonight. Then the second type of innovation.
We call. Sustaining innovations and sustaining innovations. Make good products better.
And when you just look. At the world. Most of the innovations that we see are sustaining innovations that make good products better.
They have a different effect on the economy. However in the sustaining innovations create few if any jobs and theyre kind of in neutral as it relates to capital the reason why sustaining innovations dont create a lot of jobs is when you sell a better product. The customer.
They dont buy the old product toyota developed a marvelous a hybrid car hybrid car called a prius but whenever they successfully sell a prius. They dont sell a camry. And by their very nature.
Sustaining innovations are replace it if in character. And thats why they dont create a lot of jobs then the third type of innovation. We call efficiency innovations efficiency innovations allow you to make the same products at lower prices to sell to the same customers so in america.
We have a beautiful online insurance company called geico same products. 15. Lower price.
Walmart is an efficiency innovation. Theyll they can sell the same products to the same customers. At 15 lower prices and efficiency innovations also are very critical to the economy.
If we dont have them then whole economies would would be blown out of the water. But they reduce jobs by their very nature so in america over and over again you see this if if walmart is going into a town as they build their store. They hire a lot of people but in aggregate.
Generally there are about fifteen percent fewer jobs in that area in retailing when they have done their work. But interest interestingly efficiency. Innovations free capital and what i mean by that viola stration is before toyota came to america it took the american car companies about 60 days to assemble a car and as the car crawled through this plant there had to be a lot of work in process inventory on the balance sheet to support that process toyota figured out how to assemble a car in two and a half days and because it dipped through the process they didnt need to have nearly as much wake work in process inventory on the balance sheet.
And it essentially took capital that had been imprisoned on the balance sheet. And it freed it up to do remarkable things and so. Its kind of a meet of almost like a perpetual motion machine as long as we create more jobs through empowering innovations than efficiency.
Innovations. Reduce and as long as the capital thats created by efficiency innovations create enough capital to fund empowering innovations. It just keeps going and going and in fact in america for the first six recessions.
This seems to work well and just almost like clockwork we reset itself. But then weve something has gone wrong and my sense of whats gone wrong is right here finance has cut this circle and created a system where theres the beginning and an end essentially and really what finance is causing us to do is take efficiency. Innovations and reinvest in efficiency innovations over time theres a theory is a very important element in everything that we do and finance has a really strong theory associated with it and part of it is an observation that the shareholders are important part of it comes from calculus you have to have something to manum minimize or maximize or calculus isnt or very worthwhile and friedman gave us this assertion that the the role of management is to maximize returns to capital to the shareholders.
And and he solved a problem of mathematics needs something to optimize and so it was assumed that thats what finance was about then in addition to having a really. Powerful theory set there are tools that are available for finance and i want to assert that the development of the spreadsheet by dan brickman at the harvard business school had a bigger impact on management than almost anything in the last hundred years as i when i was an mba student at harvard. They taught me how to calculate internal rate of return.
And i had a four function calculator in the mid 70s. And i had a pencil and a sheet of paper and we had to work out the pro formas and then i remember i collect equate and i came up with an internal rate of return that clearly was not right and it was just so difficult that we had a concept internal rate of return. But we really couldnt use it per se and thank goodness for these spreadsheets because you could build a model of a company and then test well if i change this input or this assumption.
What will the impact be on internal rate of return or return on net assets or whatever. And and and it had a huge impact as youll see then finance. Really has become a profession not just a job and and then its led by powerful people intellectually.
And its just of its own finances. A machine. The impact that this has had is that now a 26 year old analyst.
Who has a spreadsheet can figure out what inputs need to be of what levels to get what outputs that theyre going to use to measure whether the management is being successful or not and so you have this odd situation. Where somebody who has never run a company sits across the desk from a manager and tells them how to run the company and its interesting that the managers obey the commandments that finance gives to them increasingly finance takes charge of how the economy works. Now.
Theres a really smart. Economist. Named george gilder.
And he made an assertion that if you get all of the inputs that are required to make an output a product or service. That youre going to sell some of these inputs are going to be very abundant and cheap like sand and things that are abundant and cheap you dont have to worry about them you dont have to keep account for them in any way. But he points out that other types of innovations are scarce and costly and things that are costly in scarce you got to really watch.
Them and husban their use and deploy them only in places in the market. Where theyll yield the highest return for the use of these about these. Scarce resources well.
As this juggernaut of finance emerged because of their power they observed that capital through the 1930s 40s 50s 60s and 70s was with scarce and very costly and therefore thats what we ought to measure is are we deploying capital in applications. That yield the highest return an interesting thing that finance is done to managers is theyve given them options so before all of this happened the way a manager measured profitability was with crude measures like tons of cash and now finance is given managers. Ratios and this sophistication.
Gives them options so for example. The third one their internal rate of return is a common measure. Its a ratio and the numerator is profit.
The denominator is speed and so i can get internal rate of return up in one of two ways make more profit through innovation or only invest in projects that pay off very short term either way get internal rate of return up and so finance brought to management. This logic and the language of ratios. So what impact has that then had on this on this process.
Well you create more capital through efficiency innovations and then the analysts have to think gosh. We got capital. Where should we deploy it and by using these ratios they realized gosh the problem with empowering innovations is those things pay off in five to ten years and wed actually have to take capital and stick it back on the balance sheet on the other hand.
If we took that same capital because of these commandments and and recycle it back in efficiency innovations. The great thing about efficiency innovations is they pay off in a year or two and instead of using capital they create more capital what a deal and so they reinvest in efficiency innovations. More money comes out and then they say geez.
I wonder what we should do with this capital. We just do one in and over again and still in americas economy. There is still a little bit of capital that goes up into empowering innovations.
But my sense is that over the last 20 years. The number of empowering innovations that our economy is generating is about a third the level that it was in the 50s 60s and 70s. What we see here is that private equity shops and hedge funds.
Just complain that there is so much money chasing few so few deals and entrepreneurs complaining that they cant get funding. And whats happening in our economy is because of this recycling of into capital. We are awash in capital and the cost of capital is nearly zero and yet we cant create new jobs because the financing mechanism.
Hijacks capital and recycles it into itself. And where is this heading is an interesting question through the remember during the 1960s 70s in the early 80s. Japans economy was just a juggernaut japan was growing at unprecedented rates in the world and they transformed themselves from poverty into prosperity in about 25 years.
What is it that was the engine of japans miracle. It was that they in my language. They disrupted america through empowering innovations.
So for example toyota made a car that was so affordable that the low end of humanity. People we called teenagers today could own a car. Remember what sony did they made rusty little some pocket radios that cost.
2 that made millions of people and they enabled them to have music wherever they went and kenan made a printer so affordable and accessible that we could have one in every office and every home. And because of these empowering innovations. Billions of people around the world had access to these products by companies made in japan and for 30 years their unemployment rate was less than 2.
If you were alive you had a job but starting in the late 1980s. The successful japanese companies started to hire graduates of business schools in the west who brought with them this logic of how to measure investments into how to guide things in ways that maximize return on net assets and internal rate of return. And my sense.
I think im right is that since 1990. Japans economy has generated only one empowering innovation and that is the nintendo wii. Its the only one and their economy has been dead or flat for 23 years they are awash in capital.
The cost of capital is zero. And they just cant get out of it and i think that capital isnt the problem. The problem is the way we calculate success makes it impossible for innovators to invest in the kind of things that create jobs and so we have recoveries without without jobs.
The jobless recovery that you illustrate at the beginning. And its been a similar source of story in the in the uk here. I dont know about america things are a lot of political calls for redistribution and different role for the states.
If if this if this theory is is is correct redistribution alone wont lead to a rekindling of that of that cycle. You have a general sense of youre exactly right rohan. So.
I i think the republicans and the democrats are both wrong on this redistribution issue. So in america. The top one percent owned actually about twenty eight percent of the disposable income right and the republicans.
Say you have to allow these people keep their money because theyre the ones that invest in jobs. And thats actually not true a few of them invest to create jobs. Most of them use their capital to make more capital right and but then the democrats.
I think are wrong as well in that if you dont have any empowering innovations. Emerging in america. And you give people.
Some of their money for to spend theyll invest it on sustaining innovations. Because thats all thats available and by their very nature. It doesnt create jobs so its just its just like flooding the economy with more capital doesnt solve the capital problem.
And redistribution doesnt solve the job problem. It really is empowering innovations on empowering innovations. I thought your point about efficiency innovations kind of emancipating capital is important i wonder whether they can emancipate intellectual property as well.
Which might be leveraged. Elsewhere and isnt very interesting. And then maybe the other thing that would be interesting to think about would be you know an empowering innovation.
Were talking about them as products often but it strikes me they may 3 tech nology more often be platforms now products no i think weve seen that with apple. Where they kind of maybe employ less people than you would imagine to create that many apps and actually the employments external and then i wonder if it could include services as well so and sometimes whether these solutions could be services. So venture capital could plug this gap more drive empowering innovations and maybe they themselves the venture capitalist can act as they are empowering innovations.
Theyre supporting. It and they are that process that alternative finance maybe crowdfunding in the future can be empowering innovation. Itself is that product and service is the wrong way to categorize things in america and i think you guys saw it before we did the ability to learn online has created an extraordinary boom in that market.
And its because some of them are sustaining innovations you can teach physics 101. Better online than you can in most physical classrooms. But most of it is in empowering innovations.
It enables many more people to learn many more things at lower prices and its created really exciting jobs you .

a person who asserts a right of recovery under an insurance policy is called-0
a person who asserts a right of recovery under an insurance policy is called-0

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