Tuesday, June 14, 2011

Innovation deficits and debt

The US Government, along with many other governments around the world, is beginning to come to grips with its fiscal deficit, and, hopefully, its long term debt.  A deficit is a current year short-fall that occurs when spending exceeds tax receipts.  A debt, on the other hand, is the accumulated deficits.  Both are pernicious, and both must be addressed, or, like Greece, we'll all find ourselves in the uncomfortable situation of dramatic cuts in government services or paying extreme taxes to pay down our creditors.

Another factor you should watch closely is big business, at least in the US.  Right now, many businesses are reporting exceptional profits in the face of a slow economy.  I'll argue they are doing this in many cases by driving two significant deficits, which are leading to debt.  Neither of these deficits will show up as a negative on the balance sheet in the short term, but may cripple the firms in the long run.

The first deficit or debt is in information technology.  Many firms are simply relying on existing software and existing systems to get them through these lean years, and are investing far too little in development and new systems.  Many IT organizations are barely able to sustain their existing infrastructure, much less add new functionality.  Many are also hoping to take advantage of a generational shift to the "cloud", which they believe will dramatically reduce IT costs, but they aren't taking into account the dramatic costs of shifting to the cloud.  In the next few years the lack of investment in IT will be obvious and CEOs in the near future will have to invest in IT to continue to drive revenue and profits, demonstrating the deficit and debt around IT spending.

The other deficit or debt that is near and dear to my heart is the innovation deficit.  In this economic environment most firms are satisfied with sustaining the status quo, and squeezing all the value that they can out of existing products or services.  They use many arguments to demonstrate why innovation is currently too expensive, too difficult or too risky.  Many executives know they need innovation in order to sustain growth and profits (see any recent CEO survey where 70% of CEOs demand more innovation), yet many CEOs also recognize that innovation isn't getting done.  For proof see the NSF survey where less than 25% of manufacturing firms and less than 10% of services firms report generating a new product.  This deficit builds to an innovation "debt" or gap, which has several implications.

First, many firms that are leaders today aren't innovating, and won't have interesting and valuable new products and services to offer.  To sustain themselves in the near future, they will have to acquire smaller firms with new offerings or risk the wrath of their customers.  Second, new entrants and upstarts will cause radical disruptions because they bear less of the infrastructure cost and have less at risk when they innovate, so the table is set for disruption in any industry that isn't very innovative now.  Third, competitors in countries like India and China that are lending us money to drive our fiscal deficits are innovating, so we can expect more and more innovation from those firms and countries.

Right now many firms in the US are whistling past the graveyard, hoping to get through a tough economic climate and get back on solid footing.  They are driving profits by squeezing more efficiency and returns from existing infrastructure and products, but at the same time creating an innovation deficit which they won't be able to fill in the coming years.  As nature abhors a vacuum, that innovation deficit or debt will be filled by someone, some firm or some country.  Don't kid yourself: short-term profits are coming at the risk of long term product and service innovation.  Our businesses are creating an innovation debt to rival the debt rung up by our government, and sooner or later we will pay for the lack of investment.

Innovation, like tax collection, isn't an on-again, off-again activity based on external conditions but a consistent requirement over time, which we may come to recognize at our peril.
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posted by Jeffrey Phillips at 5:48 AM


Anonymous Arena Solutions said...

I like your comment that "Innovation, like tax collection, isn't an on-again, off-again activity based on external conditions" - I agree, Innovation is definitely a mind-set we need to adopt. It seems like you're focusing a little more on the systems, products . . . more of the structural end of innovation. I'd like to add some ideas I have about encouraging it from within the org.

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