Strategy

Cost saving innovations make companies Profitable but not necessarily Innovative – Here is why

posted by Ravi Arora April 13, 2016
In my search to find out what makes company more innovative, I looked at the list of most innovative and the list of most profitable companies and the basis of their ranking.

List of most innovative companies:

I found three sources:

  1. Forbes: Companies are ranked by their innovation premium: the difference between their market capitalization and a net present value of cash flows from existing businesses. Market Capitalization is a straight forward number but the NPV of cash flows from existing business is based on a proprietary formula from Credit Suisse HOLT. The difference between the two (Market Cap and NPV) is the bonus given by equity investors on the educated hunch that the company will continue to come up with profitable new growth.
  2. BCG: The BCG fields an annual innovation survey of thousands of senior level executives.
  3. Fast company also released its list of most innovative companies of 2016.

The top 10 companies in the three lists were:

Top 10 innovative companies_V2

Most people think that the most innovative companies would be the most profit making also. I therefore looked at the list of most profit making companies.

List of most profit making companies:

I got the following two sources:

  1. 24/7 Wall St. reviewed companies’ operating income figures. While net income is the standard measure of profits, it can include items that do not reflect profitability such as extraordinary and discontinued items and sales of subsidiaries or major holdings. Earnings from continuing operations, however, excludes such items. Based on net income from continuing operations, one measure of profitability, 24/7 Wall St. reviewed the world’s 10 most profitable publicly traded companies. Top companies were:
  2. Insider Monkey has ranked this list based on the highest earners from Fortune 500 and Forbes. We consider these companies since they are known as the wealthiest and most profitable companies around the world. Let’s find out more about these 10 profitable companies in the world in 2015

Top 10 profitable companies_ver2

Connection between the two lists:

In the two lists of Top 10 profit making companies and Top 10 innovative companies, there were only two companies that appear in both the lists – Apple and Samsung.

‘Why do top 10 profit making companies do not appear in the list of top 10 innovative companies? Is innovation not necessary for making good profits? or doesn’t innovation guarantee profits?” And If were to stretch this a little too far – “To make good profits, you should not be innovative

There could be many reasons, but the one that I believe has most influence is the measure that is used to decide the most innovative companies. Forbes uses a formula and the other two are perception based. The one that uses formula has two inputs – One of them is the ‘Market Cap’, which already has perception built into it in terms of future expectations. We could therefore say that the list of most innovative companies have a strong influence of PERCEPTION while the list of most profit making companies is very objective based on the P/L statement.

Now let us spend some time on the PERCEPTION. This PERCEPTION is built based on the recent innovations of the company, the recent announcements made by it and the future expectations. The contribution of various types of innovation on this PERCEPTION is given below:

  1. New product innovations in the B2C space have the highest influence on this PERCEPTION
  2. New service innovations in the B2C space also has a high influence
  3. New product or service innovations in the B2B space has lower influence
  4. Process innovations has a miniscule or no influence on creating the PERCEPTION about innovativeness of companies.

The most well-known measure for innovation that some companies report is ‘Revenue from new products launched in last three years’. On the other hand has anyone ever heard of “Cost saved from the process innovations of last three years”? The answer is clearly ‘No’. Why?

While the former (Revenue from innovations of last three years) could be tracked and reported using an ERP, there is no system that helps in tracking and reporting the later (Cost saved from the innovations of last three years)! Can an ERP help in reporting cost saved from innovations?

I searched for the innovations of two companies – Exxon and Chevron, which appear in the list of most profit making companies (and I can show similar information from several Tata companies). There is a considerable amount of information available on the web about these two companies and the summary of what I read is given below:

Exxon and Chevron_ver2

Solution lies with the ERP companies:

We need to break this dichotomy (Most profit making and most innovative) and the only way to do is to give  appropriate importance to process innovations that save or reduce cost. I urge the ERP companies to provide a solution (which is not difficult and I am ready to support) so that process innovations get their due influence in deciding the most innovative companies of the world.

References: