Does Wall Street hate innovation?

21 Apr 2011 Sandeep Mehta

I found an interesting article in the Star Tribune Does Wall Street hate innovation?

Recent studies by Mary Benner, an associate professor at the University of Minnesota’s Carlson School of Management, concludes that’s often the case for major players in their industries. She examined how analysts reacted when companies like Kodak and Polaroid shifted to digital photography or when telecommunications companies began pursuing Voice over Internet Protocol technology. Analysts showed a preference for incremental change rather than breakthrough innovation. 

This is an interesting look at innovation – from the outside and from the financial analyst perspective.  The research has some significant lessons for R&D managers.  First, for publicly traded companies, innovation is expected/rewarded from growth companies and not from value companies.

The thing that separates the ones that are affected from those that aren’t is whether they’re publicly traded where expectations have been created that earnings, cash flow will be predictable. It’s very hard for them to change and do something entirely new. There are firms that are categorized as growth stocks where analysts and stakeholders are more willing to see them innovate. Even Amazon spent many years being a growth stock without a lot of expectations for predictable earnings. Private companies also have more leeway with their shareholders.

So how do companies get pressured?  They get rewarded when they focus on process improvements and efficiency enhancements such as Six Sigma that provide predictable results.  These processes actually squeeze out disruptive innovation and only allow companies to focus on incremental innovation.

They focus on mapping processes and predictable, measurable improvement. My research shows that tends to spur more incremental innovation and crowd out radical innovation. The direct effect is that Wall Street tends to react very positively when companies adopt these management practices. They can be wonderful in some parts of companies that need efficiency, stability. But they’re not always wonderful, particularly with technologies that are so new we don’t really know them yet.

Amazing! There is a cause and effect paradox here.  Large companies are often blamed for not innovating.  Everyone actually expects innovations to come from small nimble firms.  But the behavior of large firms is governed by the rewards they get from their boards of directors.  These rewards assure that the firms will actually not innovate!  This is another reason why financial incentives do not work.
However, only large firms really have the resources and manufacturing capabilities to bring products to market. Knowing this, large corporations should be better served by setting up Xerox PARC-like innovation organizations that do not get hindered by processes.  The problem then would be to have effective means of integrating the innovations into the product line.  We have discussed that several times in the past.

Leave a Reply