Points of View
Rossoff & Company’s Points of View is a forum for industry experts, leading finance professionals and senior Rossoff & Co. professionals to provide insights and commentary on current news stories, financial market themes and industry dynamics.
Innovation Capacity as an Element of Value
By Ivan Quijano (MS, MFA, MBA) Innovation Strategy Consultant
The concept of innovation long ago moved from “invention”, especially in technology, science, and medicine, to an all-encompassing and yet elusive “solution” to challenges faced by firms, organizations, governments and supra-national bodies-- as well as for individuals and societies striving to meet their aspirations.
Our contemporary discourse on innovation is arguably a natural follow up to a sequence of inventions that started with the development of radar, satellite communications and space flight. It then morphed into an explosive progression of venture capital mediated developments: of semiconductors, microprocessors, and Moore’s law; the evolution of digital signal processing, computing platforms, networking, and graphical user interfaces; the internet and world wide web; online commerce and social media; virtualization and cloud computing; robotics and the internet of things (IoT); and a myriad of related applications. Today we are fascinated by artificial intelligence (AI), with early benefits such as natural language processing (Siri, Alexa, etc.), computer vision (face recognition, etc.), autonomous vehicles, etc. “Machine learning”, the core function of AI, represents a new “arms race” where its competitive advantages include the speed of artificial neural networks; the cleverness of algorithms; and the volumes of data sets (big data) on which machines are directed to learn. Since such learning involves autonomous creation of algorithms, concerns about human control are beginning to surface.
Yes, this is a brute dump of technology developments, which I dare say connects to the finance function by virtue of the amazing value created, and by the extraordinary size of capital generated. So, my first course of food for thought is this: should “innovation capacity” be treated as a dimension of financial analysis, and consequently as a component of M&A transactional due diligence? After all, thanks to Clayton Christensen, we are evolving a mindset of defending against being disrupted by somebody else’s innovation, while at the same time hunting for growth opportunities based on our own innovation.
If so, how much weight should then be assigned to this innovation component? Curiously, would it even make inroads into traditional private equity?
The thing is, an “innovation capacity” component of due diligence doesn’t come with financial ratios or internal rate of return metrics to facilitate evaluation of potential transactions – the number of patents, or the percentage of sales spent on R&D, don’t necessarily translate into innovation for all organizations. These could be misleading, especially for incumbent firms content with their fat market share, and who are busy buying back their own stock.
Currently, there are academic debates about the definition of innovation; about what constitutes innovation vis-à-vis entrepreneurship; and also about the schools and methodologies to “increase” innovation, such as: design thinking, lean start-up, open innovation, etc. Design thinking in particular is being extended to organizations and problems beyond the product development space. It may be interesting to explore various approaches in a future POV posting.
In the meantime, I believe there is an opportunity to add “innovation capacity” as a useful element in the evaluation of M&A transactions and liquidity events. The “how” to do this will add value to the practices of finance and strategic planning. Stay tuned.