Are accountants and CFOs killing innovation?

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

When Dell announced in February its decision to take the company private, founder and CEO Michael Dell said the move was part of a strategy to “continue the execution of our long-term strategy and focus on delivering best-in-class solutions to our customers”.

One could have added that the deal was needed to give Dell breathing space — away from the demands of shareholders and the market — to re-boot its strategy and recover lost profits from its PC business, badly hit by sexier, more innovative products such as Apple’s iPad and Amazon’s Kindle.

For big corporations, making disruptive changes is not strictly a question of money; it is a question of mindset and how you position the innovative disruption on the balance sheet, which can be the pitfall.

AMAZON BOSS’ LONG-TERM VIEW

INSEAD Associate Professor of Accounting and Control Gilles Hilary, in a research paper Does Accounting Conservatism Impede Corporate Innovation?, makes the case that firms with a greater degree of accounting conservatism are less innovative because of — among other things — the requisite practice of immediately provisioning for future losses.

“The principle of accounting conservatism is to recognise losses as soon as they become probable, but delay the recognition of profits until there is a legal claim to the revenues generating them and that revenues are verifiable,” he says. “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 Professor Hal Gregersen, Senior Affiliate Professor of Innovation and Leadership at INSEAD — but it did not deter innovators such as Amazon founder and CEO Jeff Bezos.

“It’s important to remember that every major risk that Bezos has had Amazon take, the markets had actually been very negative,” Prof Gregersen told INSEAD Knowledge at the Unleashing Innovation conference in Singapore in February. “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. We know the story — it worked.”

The markets crushed Amazon stock on two other company announcements: The move into e-readers (Kindle) and cloud computing. Both times, the bets paid off. Sales have more than tripled from US$14.85 billion (S$18.83 billion) in 2007 to over US$48 billion in 2011, illustrating the benefits of taking the long-term view that Mr Bezos often talks about.

It is well-known that he includes in every Amazon annual report the company’s 1997 letter to the shareholders, reminding them that “It’s all about the long term”.

Mr Bezos states: “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.”

TOLERATE INITIAL FAILURE

Assoc Prof Hilary says that “cash-flows generated by innovations in firms with more conservative accounting have shorter horizons”, and that “the negative effects of accounting conservatism on innovative activities are more pronounced when firms operate in innovative industries”.

To encourage innovation, he adds, “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 have much to learn from Amazon. Mr Bezos’ courage to think long-term in such an innovative and high-tech industry has minimised conservative accounting’s negative effects. All well and good — but you still have to convince the CFO, whose job is, after all, to be cautious.

Prof Gregersen says: “You get a CFO often coming in to a bright new idea using language like, ‘The marginal cost of our equipment can deliver something far cheaper than the total cost of this new investment’. He’s going to use this marginal cost logic to say, ‘Don’t invest the money, CEO. It’s not a good idea.’ As a result, a company misses out on what could have developed into a long-term cash cow, like Kindle for Amazon.”

YOU CAN TEACH CFOS INNOVATION

That is not to say that CFOs and accountants are a guaranteed death sentence for innovation.

In his book The Innovator’s DNA, Prof Gregersen gives the example of Mr Mike Collins, founder of 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. The CFO’s creativity skills were close to zero.

“But, over the course of nine to 12 months, just by being around others who think differently and act differently, he said the CFO’s creativity went up to 30 to 35 per cent, which is 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 go in a different direction.

“So, where the culture itself was pretty innovative, it helped the CFOs elevate their creative capacity.”

But what about CFOs who work in companies that do not have an inherently innovative culture? How should such CFOs go about becoming more innovative?

“I would write down, four or five minutes every day, all the questions I had about a problem, and it would lead to new questions, which would create new solutions,” says Prof Gregersen. “I’d think about places I can go to observe situations which might give me insight into an issue. I would identify three or four people outside my industry, in a different geography perhaps, and get their perspective on the problem.”

“If (that CFO) did these things, I’d be stunned if he or she didn’t walk into the next senior executive team meeting and deliver a different and better perspective on the problem. It takes legwork and homework … But it leads to creative ideas that help a strategic-thinking group of people to go in a new direction.”

ABOUT THE EXPERTS:

Gilles Hilary is Associate Professor of Accounting and Control at INSEAD. Hal Gregersen is Senior Affiliate Professor of Innovation and Leadership and the Abu Dhabi Commercial Bank Chaired Professor of Innovation and Leadership at INSEAD. He is Director of Learning to Lead, part of INSEAD’s portfolio of executive education programmes.