How Much Is The Future Worth?

All investment is about the future. Sometimes you invest in a future that plays
by the same rules as today. Other investment is about a new future that plays
by new rules. If you take investment decisions on the new future based on the
today’s rules then you can make big mistakes.

Investment decisions are a tricky business. To make them easier, managers often
use tools to help with the financial analysis. The problem with these tools is that
they value innovation and non-innovation in the same way. They encourage
managers to make unfair demands on returns on investment for internal
innovation projects.

Ignoring the future is easier on the brain but it makes investing in the future
harder. You don’t know what will happen but you must assume that doing
nothing new will make things worse. You cannot maintain the status quo so the
only way of maintaining your status in the future is to make innovation
investments now. The question becomes not “should we invest in innovation?”
but “what innovation should we invest in?”

Estimating the future is guesswork. That’s the best we can do. Don’t confuse
forecasting with foreseeing and place too much faith in the numbers in your
business models. Don’t avoid questioning your own guesswork and trying to do a
better job of describing the future. Don’t limit your guesses to only a couple of
years into the future. If you do, the costs of innovation will look bigger and the
benefits will look smaller than they are likely to be – much like looking through
the wrong end of a telescope.

Accepting the future will be different can help free investment thinking. Crazy
ideas will create mass markets. Bizarre business models will revolutionise
industries. Stuff that you reject will come back and haunt you. The opposite of
what works now may be the new orthodoxy. You still don’t know what will work
but investing in a portfolio of radical and incremental innovations is the sensible
approach to certain uncertainty.
Short-changing the future occurs when managers compare investments by
looking at how much more cash is required in addition to spending on existing
fixed assets. If the investment uses existing assets then it will appear to cost less
and create more profit. If an innovative investment does not use existing assets
then it will appear to cost more and create less profit.

You hope that investment in brands, training, and equipment will protect you
from new competitors. You hope that investment in the old way of doing things
will act as a barrier to new entrants. It does. It stops new entrants wanting to do
things in the old way, your way. It doesn’t stop them doing things in a new way.

And if they figure out a new way that works, your investments may act as a
barrier to you abandoning your old ways, ways that no longer work. You don’t
want to write off assets that still function but are no longer competitive, so you
delay the decision yet further.

Selling out the future happens when you focus more on short-term results than
the long-term health of the company. Most of this pressure comes from what
managers think that shareholders want. If you receive incentives based on share
price, you tend to make decisions based on raising short-term earnings per share.
You can even be tempted to use excess cash to buy back shares instead of
investing in innovation. It increases the share price temporarily but does nothing
to secure the future of the company. Shareholders start to react to earnings
announcements more than to product or strategy announcements.

Thriving in the future means innovation. Many managers are incredibly generous
when it comes to setting prices for buying acquisitions to play innovation catch up
or returning money to shareholders to boost the share price and their own
incentives. They need to be equally generous when determining how much to
invest in innovations that will secure the health of the company in the long-term.

Discounted cash flow, net present value, marginal costing, and earnings per share
often underestimate the necessity for innovation. Use of such techniques can
disguise faulty assumptions about the future that prevent companies preparing
for it until competitive crisis occurs. Your future deserves better.
References

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Barnett, DF, 1986, “Up from the Ashes: Use of the Steel Minimill in the United
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Christensen, CM, Kaufman, SP, Shih, WC, 2008, “Innovation Killers: How Financial
Tools Destroy Your Capacity to Do New Things”, Harvard Business Review, Jan 1,
2008

Kochhar, R, Pathiban, D, 1996, “Institutional Investors and Firm Innovation: A Test

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