End the Religion of ROE

1:51 PM Thursday October 20, 2011 
by Chris Meyer & Julia Kirby

[W]e believe that corporations would do better for all their stakeholders and avoid the risks of runaways by focusing on Return on Innovation. An innovation-based measure would lead to an acceleration in investment with positive benefits for growth.

A new DuPont equation would measure the growth in value created by innovation (and again, that is value defined broadly). And like the original, NuDu would decompose this measure into three components:

The value of an organization's innovation per person affected

The number of people affected by an innovation

The frequency with which the entity innovates

Arithmetically, that's equivalent to saying:

How does this guide decisions and actions in a different way? First, by stressing that the point is innovation. A dynamic economy requires growing companies—those that increase their value-added contribution over time. To maximize this, a company should prioritize the innovation that leads to the greatest value. That value must be measured across all stakeholders.

Second, an innovation should have the widest possible market. As the late C. K. Prahalad pointed out, the "bottom of the pyramid" is a market and not a social problem. In a recent talk at MIT, Infosys founder Narayana Murthy put it this way: "Technological innovation is all about reducing cost, reducing cycle time, making life more comfortable. Therefore: who needs new technology more than the poor?

And third, the battleground of competitiveness now goes beyond time to market, to include the frequency with which a firm brings valuable innovations to market. GE, by creating independent local development teams, is adding to the diversity of ideas and the opportunity to recombine them, and hence the likelihood of having innovations to bring to market more often. "More products at more pricepoints" is their name for this strategy.

Looking at Apple, you'd conclude it had been using this equation for a long time. It has focused on building an ecology, earning its fair share of the rewards but leaving plenty for others who can earn them (at the expense of those who have historically extracted margin from market power by restricting the market). Apple's offers are more highly valued than its competitors '— largely for intangible reasons ranging from design to sustainable disposability — and have extremely broad appeal globally. And it has brought true innovation to market more frequently than perhaps any other consumer products company ever.

If our new feedback loop were put in place, managers would take seriously the objectives it targeted and start trying to make themselves as good by that standard. Enterprises — and this formula applies equally to businesses, government agencies, and NGOs — would find ways to organize around its components.

It's impossible to imagine all the ramifications when even superficial incentives are changed, and therefore even as we propose this change we don't pretend to know what unintended consequences it might cause for companies and society. After all, ROE was a good thing for decades, until it wasn't. Measurement systems first educate people on what's valuable, then enlist them in figuring out unanticipated ways of creating that value, and finally degenerate into mindless games played for artificial advantage. Could this happen to measurement system based on growth of value for all stakeholders through innovation? Absolutely. But it will buy capitalism a lot of time to figure those out in the meantime.

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