Clay Christensen warns CIOs that smart managers are doomed to fail

There is more than one way to disrupt the market. In addition to disruptive market-creating innovations, which succeed by offering products or services to a class of customer that previously didn't exist, there are sustaining innovations. These succeed by replacing good products with better ones (Prius for a Camry). Efficiency innovations, on the other hand, succeed by offering the same product at a lower price (Geico). Each plays a different role in the economy. Market-creating innovation requires capital and creates jobs. Sustaining innovation is "replacetive" in nature and, while making the economy more vibrant, does not generate a lot of jobs. Efficiency innovation eliminates jobs but frees up capital for other things. It's kind of a neat system, Christensen noted.

"As long as the market-creating innovations are creating more jobs than the efficiency innovations are taking out," he said, "and as long as the efficiency innovations are creating enough capital to fund the market-creating innovations, it is like a perpetual motion machine."

But since the 1990s, this nifty machine -- the envy of the global economy -- has been under assault from the "Church of New Finance," his name for the doctrine taught at places like the Harvard Business School, he said, that measure profitability by how efficiently a company uses capital. What the new ratios offer is two ways to achieve good results. Return on Net Assets (RONA) comes out just fine by either increasing the numerator or decreasing the denominator. "Either way RONA goes up," Christensen said. The same holds true for internal rate of return, the ratio that basically expresses how quickly one can get money out of an investment. Innovation is hard. Since those market-creating innovations that generate jobs often take five to 10 years to pay off, wouldn't it make more sense to invest mostly in efficiency innovations?

The end result of pursuing that strategy, however, is that profits accumulate but job growth declines. "That is why we are not getting out of the recession and why we are not creating jobs," Christensen said. And the doctrine makes no sense, he added, giving the audience a glimpse of the passion bordering on rage that fuels his pursuits. A scarce commodity when these measures took hold, capital is abundant today. The cost of capital is zero. America is awash in cash. Instead of hoarding capital, companies should be pouring it into innovations that create jobs. And yet, the management tenets of the Church of New Finance -- which protect capital at all costs -- "make it impossible for smart people to do what needs to be done to sustain growth in the industry," he said.