Innovation as an Asset

I do not really understand the stock market. I do not own any shares. Well at least not directly – I have pension funds, but they seem rather remote. I have some friends who own ARM shares. They are not technical, so they asked me what ARM did and I said that they made chips like those used in mobile phones [I know that is not strictly true]. They could not understand how a billion handsets a year get produced and yet ARM’s shares remain in the doldrums. And frankly, neither can I.

A few years ago, however, I did gain some insight into how companies are run and this gave me a few ideas …

Not long after I started my first job, I was sent on a course – something like “Sales Techniques for Engineers”. [I know this sounds like something Scott Adams would dream up, bit it is true]. Right at the beginning of the class the instructor asked us a question: “What is the primary function of this company?”. He got answers like: “To make testing machines”, “To serve our customers” and “To dominate the market”. The correct answer was: “To make money”. Obvious really. Why else would you run a company? So, then I was quite clear that you could recognize a well run, successful company, with a high likelihood of rising stock value: it would be one that made a profit.

But life is never that simple. A few years ago I was taking a particular interest in the activities in a company. One day they announced a loss on the quarter and their shares gained value – not by an enormous amount, but definitely a positive movement. I was confused. A little study revealed that, a few weeks before this announcement, the board of the company had predicted a modest loss. This was why the stock went up: they had predicted the business performance accurately.

This is the crux of the matter. In the business world – in the West anyway – good management is equated with predictability. If you are running your business well, you know exactly how much money you will make [or lose!]. Such knowledge is respected universally and the attitude even finds its way into politics. When did you last hear a politician answer a question with “I do not know”?

This does not sound too bad until you consider the implications. The management of large, publicly owned companies will never take risks. In a high technology business, this means that they are very wary of innovation. Most truly novel technologies and products are developed, initially at least, by start-ups. These small companies may quickly be acquired by large corporations, once the risk level appears to have reduced. It is not uncommon for talented staff to leave a large company, form a start-up to develop a radical idea and then get bought by the company that they previously left. This system seems to work, but there is a wasted opportunity.

As I said, start-ups are often formed by guys leaving large corporations, but there are probably many more staff members of these companies, who have innovative ideas and the talent to progress them, but do not want to turn their back on the security of an established firm. How can this resource be harvested? One way would be for larger companies to “sponsor” a start-up – essentially forming a company within a company. They would provide the capital to start the innovative development. This funding would be a fixed, predictable amount, which should keep shareholders reasonably happy. The start-up team remain on the staff of the larger company, so they feel “safe”. Though they will never become super-rich, they would have the satisfaction of being able to bring an idea to fruition.

There is a downside of this “sponsored start-up” idea. If the innovation is highly successful, the company may make an enormous, unpredicted profit. But I feel that is one risk worth taking.