Are Accountants and CFOs Killing Innovation?

Alvin Lee, Web Editor, Featuring Professors Gilles Hilary and Hal Gregersen |

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

When Dell announced in February its decision to take the company private in a deal estimated at US$24.4 billion, founder and CEO Michael Dell said in a statement that the move was part of the strategy to “continue the execution of our long-term strategy and focus on delivering best-in-class solutions to our customers as a private enterprise.”

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

Gilles HilaryFor big corporations – regardless of industry – making disruptive changes isn’t a question of money: many have substantial budgets and can ride out the disruption. It’s a question of mindset and how you position the innovative disruption on the balance sheet– and that can be the downfall.

INSEAD Associate Professor of Accounting and Control, Gilles Hilary, in a research paper entitled “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 accounting practice of immediately provisioning for future losses. Hilary writes: “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.”

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

The Long Term View

The pressure to meet quarterly and annual financial targets is indeed great, says 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 have actually been very negative when he takes the risks,” Gregersen told INSEAD Knowledge in an interview during his appearance 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 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 (Kindle) and cloud computing; the bets paid off both times. Sales have more than tripled from US14.85 billion in 2007 to over US$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.”

Innovation Exemplified?

Hilary wrote in his research 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.”

Hilary adds, “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 Seattle HQ churns out products that contribute to the aforementioned revenue streams. Perhaps more importantly, Bezos’ courage to think long-term in such an innovative and 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 the CFO whose job, after all, is to be cautious.

“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,’” Gregersen elaborates. “So I’m gonna use my marginal cost logic on you 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, much like the Kindle has for Amazon.

Can You Teach Innovation?

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

For his book, “The Innovator’s DNA”, Gregersen gave the example of 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 in the company. He said that the CFO’s creativity skills were close to zero when he came into the system.”

“But over the course of over nine to twelve months, just by being around others who think differently and act differently, he said the CFO’s creativity went up to about 30-35 percent, 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.”

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 to help the organisation?

“I think 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 will create new solutions,” says Gregersen. “I’ll think about places I can 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. 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.”

 

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 the director of Learning to Leadpart of INSEAD's portfolio of executive education programmes.

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Comments
Strategic Bean Counter,

When I passed the CPA exam, FASB 13 had just been issued. i have lost track of what number they're now on but it's well north of 100. The reason is to reduce the accounting creativity that seems to keep leading to misreported financial information.

The authors are confusing "controllers" and CFOs. Most CFOs today aren't accountants by training so don't come with green eyeshades anymore. Most CFOs are between a rock and a hard place. CEO's that can't innovate or meet shareholder expectations then expect the Finance folks to get "creative" and manage the numbers.

CEOs need the courage of Bezos to do what's right for the business and have the confidence that shareholders will be rewarded for their patience. Cashflow is cashflow. Not enough people understand the concept...

Strategic Bean Counter
Jayherron.herron@gmail.com

Mohit Garg,

I think it is incorrect to beat up on CFOs for a lack of innovation. There are deeper problems in the organization if you find a CFO who does not understand the business or the risk taking (one view of innovation) context. If there is no common understanding of risks necessary for business, then there is a problem with the company leadership and communication as a whole.

Mohit Garg
theprotean1@gmail.com

javvadi,

From the perspective of strategic risk mitigation it is not right to conclude that accounting conservatisem is an hurdle for innovation.

Very often the perceived opportunities (unknown unknowns) are emotionally attached to the proposer and lacks objective evaluation of opportunities and associated risks to capture the same. The success or failure is measured by the cash flows generated and ability to generate potentially. It is arrived at only by an accounting process and not any other.

It may be the need to really introspect " are the failed business deals (so called innovations) , are attributed to accounting conservetism...?

javvadi
javvadih.rao@gmail.com

Abel T. van Staveren FCA MBA,

Classic case of shooting the messenger?
The dell example in the article illustrates that it is the short-termism of markets, not the CFO that is is the bottleneck to innovation. Accounting standards allow innovation costs to be capitalised if certain conditions are met. Comes down to whether or not cashflows are expected to be generated or not.

That assessment is not solely down to the cfo, it is the whole Exec team. Low probability times high cash flow can still result in positive NPV so no need to provide for losses if positive cashflows are possible and expected.

I am sure Bezos expected positive cashflows from the kindle in the long term. Otherwise he would not have done it and his CFO would have helped him quantify the risks and the pontential cashflows. Actually the CFO as sparring partner in these situations can be a catalyst for innovation rather than a hindrance.

Abel T. van Staveren FCA MBA
Abel-thomas@msn.com

Debu,

When i went to do MBA from an US business school, a note was given to us, in the strategic cost management class, the first paragraph of which said the following

"The discipline of management accounting is not where strategy comes from. Neither is it the source of notions about leadership or the source of tools related to producing goods and services or the source of ideas about how to promote and sell those goods and services". Management accounting is the activity managers do, in order to ensure that the result of strategizing, leading, operating, and marketing is that the business makes money."

Debu
debasish@gmail.com

Efrat,

"CFO" and "creativity" are a very dangerous combination. It's one thing for the CFO to understand the technology and work within an agile business model, and it's another thing to ask them to be "creative", especially with financial reporting, and especially in public companies under the watching eye of the SEC. There is zero tolerance in the US for accounting creativity (see Groupon, Enron, and hundreds of other companies being subject to SEC investigation every year).

Also, one cannot really draw any conclusions from Amazon - it's a Wall Street darling, and an outlier that goes against every financial valuation theory that is based on fundamentals. There hasn't been and likely will not be another Amazon - a company that triples it's revenues in three years, and yet is barely breaking a profit, while trading on a P/E multiple in the thousands... there are very few examples like that.

Efrat
ekasznik@foresightvaluation.com

Brian,

It is a mistake to think that innovation within a company is hostile to the external reporting requirements. It is also wrong to assume that innovation and prudence are contradictory.

My work is primarily with companies pursuing lean thinking. There are many CFO's who are innovative both within the finance and Accouting processes, and in the broader business.

Brian
Bmaskell@maskell.com

aslam khan,

I would like to put these problems in the perspective of change management. As a management accountant we are not penny pinchers but come armed with analysing non financial information too for strategic decision making.

Yes the market economics are considered and due diligence are done on a holistic view based on financial numbers which the non financial factors are supporting. So, for example a new expansion strategy would be scrutinized not just based on numbers, but implementability of that strategy and the market power that the strategy would provide in the long term horizon, which has to be reasonable.

aslam khan
aslam810@gmail.com

Brian Maskell,

Efrat:
I would completely agree with you about the need to strictly adhere to external regulations regarding financial reporting.

But there is a great deal of innovation that can be made with internal reporting - management accounting. I see so many companies pushing ahead with the same management accounting for year after year. There are much better and less wasteful ways to provide the internal reporting that is really helpful and drives the company forward.

We must create a management accounting system that is really helpful and understandable for the operational people in the company. Few companies have this.

These changes come not so much from the financial area. The real innovation in the company must come from the evaders and the operational people, but as financial people we must be quick to follow their lead and create financial system and processes that truly help them. Very often this requires us to move out of a finance department and become a part of the operational teams where our financial & analytical skills can be practical, useful, and relevant.

Brian Maskell
Bmaskell@maskell.com

Davies,

Cash is ultimate king. Implies that innovative ideas also need to meet the business hurdle rate. Strategic accounting exists to support this evaluation, and not as a hindrance.

KODUKULA,

There is some truth in this article. Accountants and CFOs are acting as stumbling blocks in the path of innovation. Their conservatism and to limit their budgets prevent them from opting for innovation. But, no community can ill afford to ignore innovation. If this vital thing is ignored, it is to their peril and for the organisation as a whole. For sustenance, innovation is a sine qua non and Accountants and CFO must come from the clutches of inertia and encourage innovation in their working and also for the survival of an organisation. Both CEO and CFO are two faces of an organisation and CFO must be realistic for the overall growth of an organisation.

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