Early Indications July 2019: Time for innovation?

Before we dive into this month’s newsletter, I have some professional news. In August I will join the faculty of the Syracuse University school of information sciences. My first task is to investigate restarting the school’s professional doctorate program. Much like a DBA (doctorate in business administration) in contrast to a Ph.D. in accounting, finance, or whatever, the Doctorate in Professional Studies is aimed at mid-career professionals in IT, librarianship, analytics fields, and similar domains (including the military). The emphasis is on applying academic knowledge to real-world situations, usually in some form of a case study method, as opposed to creating new knowledge. If you know of people in your network who might be interested, or if you have thoughts on what or how we should be teaching, please let me know: I’m in exploratory mode and many options are still in play regarding curriculum, class formation, admissions, and the thesis process. There is a personal side to the story as well. All in all, I’m very fortunate and excited to be starting on a new chapter.

If you look at this month’s title, it can be read two different ways, and I will address both. I’m working with a technical executive at a private equity-owned company, and he has crystallized some things I sort of knew. If you are a new CEO, let’s suppose, you need some time to learn the business but also need to deliver results sooner rather than later. Let’s suppose you have 3 years to bring home some solid results. There are a very small number of levers you can pull:

-buy more revenues via corporate acquisition
-expand the existing market by demographics, geography, or new use cases
-buy back shares with cash
-cut costs, usually via layoffs or selling off a business
-get more out of existing assets by motivation, improving execution, improving the talent base, etc
-change the business model: products can be sold as services, retailers can go omnichannel, point offerings can become systems solutions, and so on
-launch something completely new after some form of innovation process.

Which of those tasks can you achieve in 3 years? True innovation may offer the biggest upside, but given the short time window for executives to keep their jobs, innovation is too risky to bet one’s job on.

The history of Kraft Heinz proves instructive here. Private equity bankers started with Heinz in 2013, radically cut costs, then bought the larger Kraft two years later. Unlike 3G Capital’s previous success stories (Anheuser Busch and Burger King), Kraft has not responded to the ruthless cost cutting that included memos encouraging employees to print on two sides of each page. The merged Kraft Heinz (revenues of $26 billion) then in 2017 tried to buy Unilever (revenues about $54 billion), reflecting 3G’s fondness for the ratchet play it had more successfully executed in the beer business. Execution in the food world proved harder to demonstrate, however, and the stock price dropped 27% in a single day following a $15 billion write-down this past spring. A line of healthy but “comfort” foods co-launched with Oprah Winfrey has failed to gain traction, for example, and the SEC is investigating accounting practices in the firm’s procurement area. Meanwhile Kraft’s power brands lag competitors and the current upheaval has resulted in financial reports being issued months behind schedule. (For more, see this and this.)

Consider that the Kraft Heinz CEO who left in July was a 3G partner: even he had a finite timetable. Innovation in consumer goods segments is notoriously difficult: “New” Coke is still taught as a cautionary tale in business schools 30 years after the debacle. Now consider business-to-business markets like chemicals or industrial components like ball bearings or hydraulic fittings, where innovation requires some combination of extraordinary insight, luck, and precise execution. It’s no surprise that CEOs and management teams shy away from innovation, no matter how promising or how needed, in the name of self-preservation.

Perhaps innovation cannot be funded by public or private equities markets, so what about venture capital? VCs have longer time horizons and generally don’t sweat quarterly profitability numbers. Lyft and Uber both went public as money-losing concerns, Tesla has yet to report a profit, and Netflix is financing its massive expansion of programming development with debt at the same time that subscriber growth is slowing. Where are VCs investing? According to CB Insights and PWC, Internet companies received the bulk of investment in Q2 of this year, followed by healthcare (at about 1/3 the investment in Internet) followed by mobile and telecommunications. And which companies have raised the most money? This is depressing:

1) Juul e-cigarettes
2) WeWork (how much is really there? Lead investor Softbank dialed back a planned $16 billion investment to $2 billion)
3) Airbnb
4) SpaceX
5) Magic Leap (VR software said to be very impressive by people I trust)

The biggest deal that quarter was Honda, GM, and Softbank investing in an AI self-driving startup. Meal delivery is still hot. Student loan refinancing is a big driver of growth at SoFi, another prominent startup. How many of these innovators will deliver something “insanely great”? We’ve got a new hyper-addictive toxin marketed at high schoolers, a couple financial engineering plays, a billionaire’s rocket company, a genuinely transformational online real estate marketplace, and a software that so far has been mainly used for gaming.

Compare those targets with the genuinely big social needs we face:

-rising ocean levels are beyond the “how much are humans responsible” phase of concern
-urban migration means hundreds of millions of people will soon need places to live, ways to be fed, and modes of transportation that scale to the mega-cities we are building
-increased longevity has the implication of elder care and no big country has adequate infrastructure in place for the numbers and needs of the aged expected in 2030
-democracy as a mode of governance has been broken by Internet-related technologies
-technical, financial, career, and other forms of literacy need to be improved to match the world that is emerging
-in the U.S., cities and states struggle with long-term pension and retiree health care obligations. Alaska is slashing education spending in the aftermath of low oil prices, Illinois has unfunded pension obligations of $133 billion, and New Jersey is close behind at $100 billion.

Not all of these represent market opportunities, but many do. As I have noted previously, it’s difficult to see where new planet-scale innovations will come from. DARPA, universities, and the private sector each have factors inhibiting them from driving major new thinking. Given the amount of VC investment in China, perhaps that country's mode of economic organization will give us pathbreaking medical treatments like penicillin, technologies like the Internet and GPS, healthy agricultural productivity improvements, and transportation improvements on par with the shipping container rather than the electric scooter.

But I doubt it (China has had scooter messes of its own, for starters) and the question remains: where will we see enough resources invested with a long enough time horizon in the massive market opportunities noted above? What will the investors accept as success? And in several areas (climate change and pension reform?), how will a delayed start on serious action make the ultimate task much harder than it needed to have been?