Posts from Clayton M. Christensen

I'd like to tie together two posts and make a final point on Sustainability.

In my first post for the Sustainability class, I wrote:

Clay Christensen talks about this kind of thing all the time. Big company executives are asked to calculate an return on investment (ROI) on the investments they want to make. If the ROI isn't greater than some minimum hurdle, the company doesn't make the investment. And so along comes a smaller competitor who makes the investment and they eat the big company's lunch.

ROI is not the right framework for companies to evaluate investments. ROI is for the wall street folks. They will use it to decide if they want to invest in your company. But when you make investment decisions in your company, don't use the tools that wall street uses. Use the tools that animals use. Survival instincts. What will it take to ensure that your company is around in ten years, fifty years, 100 years? That's how to think if you want to stay in business.

And then the man himself, Clay Christensen, went and wrote a post for the NY Times yesterday which I highlighted in yesterday's What I Am Reading post. Clay wrote:

So we taught our students how to magnify every dollar put into a company, to get the most revenue and profit per dollar of capital deployed. To measure the efficiency of doing this, we redefined profit not as dollars, yen or renminbi, but as ratios like RONA (return on net assets), ROCE (return on capital employed) and I.R.R. (internal rate of return).

Since this is called MBA Mondays and we are supposedly teaching a MBA style curriculum, I want to emphasize this point. Do not use Wall Street tools to evaluate investment decisions in your companies. Use the tools that animals use. Survival instincts. What will it take to ensure that your company is around in ten years, fifty years, 100 years? That's how to think if you want to stay in business forever.

But Clay's post for the NY Times yesterday makes a broader point. If the folks who allocate capital in our society – venture capitalists, hedge fund managers, mutual fund managers, etc – are using IRR, ROCE, RONA, then they are going to allocate capital to companies that are making efficiency oriented investments, not empowering investments. And our society will continue to be awash in capital with no game changing  empowering investments that create new industries.

Clay suggests that we measure our returns in "dollars in dollars out" and forget about time, " profit as dollars, yen or renminbi". That's they way I was taught the venture capital business back in the 80s. Cash on cash, dollars in dollars out. That's what matters. If it takes a decade or more, who cares? The slow capital approach.

So if MBA Mondays is a school of business, then I hereby outlaw IRR, RONA, ROCE, from our lips. We aren't going to teach those tools and we aren't going to talk about them either. We are going to talk about making money the old fashioned way. In gobs and gobs, but slowly over time, with our survival instincts fully engaged. Let's hope others do the same.

Its time to kick off my Skillshare class on Sustainability. I will do a post each week this month (on Mondays of course). I will do office hours on Google Hangouts on Mondays at 6pm eastern for 30 minutes all month. We will do a project together which is to create a sustainable business model canvas. And there are groups you can create or join to allow you to collaborate with each other to complete the project and the class.

To join today's Office Hours on Google Hangouts, please check out the Skillshare page. There will be instructions there later today. [update: you can access the office hours hangout when its live here or afterwards via an archive here]

I will start with a post on Short Term Profit Maximization vs Long Term Business Health and then will end with some comments on our Business Model Canvas project.

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If you want to stay in business forever, you have to focus on the long term. You must construct a business model that builds confidence and trust with your customers and keeps them coming back day after day, year after year.

Many business schools teach executives and entrepreneurs that business is about profit maximization. I don't believe that. I believe business is about making a profit that sustains the business and enriches the owners but is not maximized in any period (month, quarter, year). I believe the goal of a business is sustainability so that all the stakeholders (customers, employees, owners, suppliers, etc) can rely on the business for the long term.

Let's use an example. You own a business that operates on the web. You are a leading supplier of ecommerce to a vertical market. You generate $50mm in annual revenues and make a profit of $5mm a year. You see the launch of the iPhone and Android and think that your customers are going to want to connect to your business via their mobile phones. You ask your VP Product to scope out what it would take to build a comprehensive set of mobile apps that will allow this. She tells you it will take an investment of $5mm over two years to complete this project. You gulp. That is going to reduce your profits by $2.5mm a year in each of the next two years. What do you do? You make the investment because you must invest in the long term success of the business even though that is not a profit maximizing event. It may simply get you back to the $5mm per year of profits you were making before. There may be no ROI on this investment in a positive sense. It may simply be a defensive investment. You still need to make it to ensure you will be around for the long run.

Clay Christensen talks about this kind of thing all the time. Big company executives are asked to calculate an return on investment (ROI) on the investments they want to make. If the ROI isn't greater than some minimum hurdle, the company doesn't make the investment. And so along comes a smaller competitor who makes the investment and they eat the big company's lunch.

ROI is not the right framework for companies to evaluate investments. ROI is for the wall street folks. They will use it to decide if they want to invest in your company. But when you make investment decisions in your company, don't use the tools that wall street uses. Use the tools that animals use. Survival instincts. What will it take to ensure that your company is around in ten years, fifty years, 100 years? That's how to think if you want to stay in business.

One of the most difficult decisions entrepreneurs and executives have to make is the decision to disrupt their own business. Let's say you are a cable operator. You are making billions of dollars of profits each year providing voice, video, and data services protected by a monopoly business model. Along comes the Internet and it allows voice and video to be delivered to your customers via any IP network (wireline, cable, wireless, etc). You know that over time, this is going to disrupt your business. What do you do? Do you invest in this new technology and drive it into the market, hastening the decline of your monopoly protected business model or do you do everything you can to slow down the advance of this technology?

Sadly most executives make the latter choice. Most entrepreneurs make the former choice. The latter choice is about short term profit maximation but can, and often does, lead to the demise of the business in the long term. The latter choice is about survivability even though it will almost surely lead to a less profitable business in the future. Tough choice. But to me its an easy choice if your goal is long term survival.

One of the reasons entrepreneurs make these hard choices when executives don't is entrepreneurs think like owners. They have that survival instinct in their gut. They don't want their baby to die. Executives are hired guns. They are focused on maximing the success of the business (and their compensation) over a short period that they will in the corner office. They have no incentive to think about what happens in 20 years or 50 years. They know they won't be around. And so the company isn't around either.

So when you construct your business model and create the culture of your business, emphasize sustainability over profit maximization in everything you create and do. This does not mean that you don't need to make a profit. Profits are the essence of survivability. You can't and won't survive without profits. They are everything when it comes to sustainability. But just because you need to make a profit doesn't mean you need to maximize it. Balancing the need for a profit with the need to sustain the business is the art of what you must do as the leader of a business. Do both and you win.

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Our project in this course is to create a sustainable business model canvas. If you are not familiar with the Business Model Canvas watch this video:

You will either have a business or you will invent a business and then you will map out your Business Model Canvas with the goal of sustainability as you go. You can do this by yourself or in teams. It doesn't matter at all. The goal is to do this project and learn by doing.

The thing I want you to focus on the most is the decisions you make as you fill out the canvas and which ones you were forced to compromise on some goal in order to maximize the sustainability of the business. Those are the magic decisions and the ones we want to document and discuss as we go through this course.

Good luck. Hopefully I will see you at 6pm eastern today in Google Hangouts.