Platt Perspective on Business and Technology

Innovation, disruptive innovation and market volatility 4: modeling and understanding change and innovation per se 3

Posted in macroeconomics by Timothy Platt on August 31, 2014

This is my fourth posting to a series on the economics of innovation, and on how change and innovation can be defined and analyzed in economic and related risk management terms (see Macroeconomics and Business, posting 173 and loosely following for Parts 1-3.)

I outlined a four quadrant model for categorically organizing innovation according to timeframe and risk level criteria in Part 3. And at the end of that series installment I stated that I would discuss here, how:

• Different observers/participants in this (e.g. business owners or alternatively, venture capital investors) can have markedly different opinions as to what constitutes a “minimal acceptable return on investment”
• And that this means they can have very different ideas as to where a given innovation does or does not fit on this type of model.

I said that I would discuss that and its implications in depth in this installment, noting in anticipation that the differences of perspective noted in these bullet points stem from differences in how timeframe benchmarks and goals are set and understood by different observer/participants. I will also discuss how risk evaluations can differ depending on who is doing the due diligence analysis here. I will at least start all of this here, as an exercise in refining the basic organizing model and how it would apply in practice. And I begin that with the fundamentals:

• It can reasonably be assumed that everyone participating in a new business venture, or in a more established business as it branches out in an innovative direction wants this business and this innovative initiative to succeed. Everyone involved ultimately wants to see this effort turn into a source of revenue, and more than just that turn into a source of significant profitability.
• But timing can be and usually is very different depending on who is viewing this complex of processes. A business owner is in most cases going to see compelling need to roll incoming revenue back into that business to consolidate and grow, and to secure long-term business strength and profitability. If that business owner turns to outside investors to raise necessary capital to launch this innovative venture, those investors now have a stake in this business and certainly in this innovation and the business capabilities and practices that stem from it. And this stake is in most cases going to be legally, contractually defined and stated. Investors generally want to see the businesses that they invest in succeed and thrive, but they also want to capture as rapid a return on investment as possible, so they can take out personal profits and so they can roll over those profits received into new investment ventures, using those funds as a tool for further business on their part.
• This means owners see a higher threshold of incoming revenue before a sufficient level of liquid funds have been developed from sales to merit taking a portion of that out of this system as profits. Closely correlated with that, they go for a longer timeline in defining “shorter timeframe,” as that term would be used in the model. Outside investors, and particularly venture capital investors offer significant levels of funding support but they want at least some return as quickly as possible, and would tend to see a shorter delay on this than a business owner would, as constituting a skew from some set risk level, short timeframe to same risk level long timeframe (a skew from quadrant I or III in my Part 3 model, to a quadrant II or IV situation.

Business owners may want a quick return capability and particularly if they are building a new business or a new business line within a more established business, in order to capture value from a potential disruptively innovative new marketplace winner (quadrant 1, high risk/short timeframe in the Part 3 model.) But even then, they are also driven by longer-term quadrant IV low risk/long timeframe goals and strategic and operational priorities and decisions, so that their products remain viable marketplace offerings and steady, ongoing sources of profitability – and even after any new and disruptive marketplace rush.

This difference in where the quadrant boundaries are seen to reside, along the risk level and timeframe axes, has defining significance. For a business owner who is not necessarily looking for a quick profit, a delay in realizable profitability from revenue streams that do not have to be rolled back into the business might call for strategic and operational retuning and a shift in business development time tables. That can also lead to shifts in prioritization so that funds received can be used more effectively and certainly where payroll and staff retention are high priority considerations that will have to be met anyway. For a venture capital investor, a perceived shift from one timeframe quadrant to another, and particularly from a quadrant I (high risk, short timeframe) to a quadrant II (high risk, long timeframe) can mean a fundamental qualitative reassessment of risk actually faced. And this is where the precise terms of the contract between business and business owner on the one hand, and investor on the other can become crucial too.

And at this point I have to note that I am making some fundamental assumptions here that will bear some explicit discussion. First, I have written this entirely in terms of inside business owners and completely outside investors. But the boundaries between inside and outside are not always that clear-cut. And secondly, I have explicitly and I add intentionally conflated startups and I add early stage businesses, and established businesses that seek to develop new innovative capabilities of a type and scale that would call for significant new capital investment. I will at least start to delve into these issues and some alternative scenarios, and into their varying consequences in my next series installment. Meanwhile, you can find this and related postings at Macroeconomics and Business.

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