Are accountants and CFOs killing innovation?

Alvin Lee
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What can you do when penny-pinchers get in the way of your innovative ideas to make necessary, but often disruptive changes inyour company?

For big corporations, regardless of their industries, making disruptive changes isn’t a question of money. Many have substantial budgets and can ride out any disruption. It’s merely a question of mindset and how you position the innovative disruption on the balance sheet — but that can be the downfall.

In a research paper titled ‘Does Accounting Conservatism Impede Corporate Innovation?,’ Gilles Hilary, an associate professor of accounting and control at the international business school Insead, makes the case that firms with a greater degree of accounting conservatism are less innovative because of, among other things, the requisite accounting practice of immediately making provision for future losses.

“The principle of accounting conservatism is to recognize losses as soon as they become probable,” Hilary writes, “but delay the recognition of profits until there is a legal claim to the revenues generating them and that revenues are verifiable.

“The negative effects of accounting conservatism on innovation activities are more pronounced ... when the pressure from short-term institutional investors is greater.”

The pressure to meet quarterly and annual financial targets is indeed great, says Hal Gregersen, a senior affiliate professor of innovation and leadership at Insead, but it did not deter innovators such as Amazon founder/CEO Jeff Bezos.

“It’s important to remember that, every major risk that Bezos has had Amazon take, the markets have actually been very negative when he takes the risks,” Gregersen says. “'When Amazon went from just selling books to building massive, full-sized warehouses to hold more than books, because they were spreading beyond that product, the markets thought he was an idiot for investing the money in that sort of capital expansion. We know the story there. It worked.”

The markets crushed Amazon stock on two other company announcements: the move into e-readers and cloud computing. The bets paid off both times, however. The company’s sales have more than tripled, from $14.85 billion in 2007 to more than $48 billion in 2011, illustrating the benefits of taking the long-term view that Bezos often talks about.

It is well known that Bezos includes in every Amazon annual report the company’s 1997 letter to the shareholders, reminding them that ‘It’s All About the Long Term.’ Among many points made in that letter, Bezos states quite clearly: “We will continue to make investment decisions in light of long-term market leadership considerations, rather than short-term profitability considerations or short-term Wall Street reactions.”

“Cash flows generated by innovations in firms with more conservative accounting have shorter horizons,” Hilary writes. “The negative effects of accounting conservatism on innovative activities are more pronounced when firms operate in innovative industries. To encourage innovation, accounting should be facilitating the tolerance of failures at the initial stages of risky projects. This is particularly true when managers are already under strong pressure to deliver results quickly.”

In that respect CEOs and CFOs alike have much to learn from Amazon. The constant innovation that happens at the firm’s Seattle headquarters churns out products that contribute to the aforementioned revenue streams. Perhaps more important, Bezos’ courage and willingness to think long-term in an innovative, high-tech industry such as the one that Amazon is in has minimised conservative accounting’s negative effects on innovation. All well and good, but you still have to convince your CFO, whose job, after all, is to be cautious.

“You get a CFO, often, coming in to a bright new idea and using language like, ‘The marginal cost of our equipment can deliver something far cheaper than the total cost of this new investment,’” Gregersen says. “So I’m going to use my marginal-cost logic on you to say, ‘Don’t invest the money, CEO. It’s not a good idea.’”

As a result the company misses out on what could have developed into a long-term cash cow, as the Kindle has for Amazon. That is not to say that CFOs and accountants are a guaranteed death sentence for innovation. For his book ‘The Innovator’s DNA’ (Harvard Business Review Press, 2011), Gregersen gave the example of Mike Collins, founder of the venture-capital and crowdfunding firm Big Idea Group.

“Mike told us about hiring a CFO to make sure that they were making wise financial choices in the company,” Gregersen says. “He said that the CFO’s creativity skills were close to zero when he came into the system.

“But over the course of nine to 12 months,” he continues, “just by being around others who think differently and act differently, he said, the CFO’s creativity went up to 30 per cent to 35 per cent, which is about as far as it needed to be because, when he was sitting at that senior-executive table, he could not only provide input about the numbers, he could also interpret the numbers strategically and help the company to go in a different direction.

“So in that kind of situation, where the culture itself was pretty innovative, it helped the CFOs elevate their creative capacity.”

What about CFOs who work in companies that do not have an inherently innovative culture, however? How should such CFOs go about becoming more innovative to help the organization? “I think I would write down, four or five minutes every day, all the questions I had about a problem,” Gregersen says, “and it would lead to new questions which will create new solutions. I’d think about places I could go to watch and observe situations which might give me some insight about the issue. I would identify three or four people outside my industry, in a different geography perhaps, and talk to them about their perspective on the problem.

“If I do those sorts of things, and then I meet with the senior executive team four or five weeks later, I’d be stunned if that CFO wouldn’t walk into that room and deliver a different and better perspective on the problem than he/she would have otherwise,” Gregersen concludes. “It’s that kind of legwork/homework ... It takes work! But it leads to creative ideas that help a strategic-thinking group of people to go in a new direction.”

Alvin Lee is web editor of INSEAD Knowledge.

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