Elliott Parker is the CEO of High Alpha Innovation and author of The Illusion of Innovation. In this podcast, Parker joins Motley Fool host Ricky Mulvey for a conversation about:
- The power in being contrarian.
- One megacap that knows how to innovate.
- Why return on invested capital (ROIC) is not a foolproof metric for investors.
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This video was recorded on April 28, 2024.
Elliott Parker: You want to win in business? The trick is over time, you've got to be non-consensus, contrarian, and turn out to be right. If you're going along with the consensus and you're right, you will go out of business. You need to find ways to be non-consensus, to be contrarian, and turn out to be right. Right now, a really easy way to be contrarian or non-consensus is to have a long-term view, to be optimistic about the future which, right now, uniquely in the last couple of decades, it's also contrarian to an optimist.
Mary Long: I'm Mary Long, and that's Elliott Parker, CEO of High Alpha Innovation and author of the book, The Illusion of Innovation. Do you ever get the sense that innovation has become a buzzword? Something that a lot of companies talk about but few actually do. Well, Elliott Parker has had the same thought, but he's a big believer in the idea that genuine innovation can keep companies alive even in an era of shortening corporate life cycles. How can investors separate real innovation from mere theater? Ricky Mulvey sat down with Parker to find out.
Ricky Mulvey: I'm going to start with an obvious question for you. It might not be an obvious question for our listeners, though. Big companies, they got a lot of the firepower. They got trillions in capital. Why is it so hard for these big institutions to create society-changing innovations?
Elliott Parker: It's a very good question. I think it may be one of the most important questions to ask about our economy right now because if you go back 50, 60 years, a lot of the important innovations, breakthrough innovations, that we enjoy came out of corporations. Now more often they come out of start-ups. If we think about our large institutions, not just our corporations, but government schools, other large institutions, there's this broad sense that these institutions seem less capable than they once were of confronting change and opportunity. I think it's a really good question to ask why that is, and then to follow that up with what do we do about it? My view is that, in a nutshell, we've gotten really good at running large organizations. In fact, we've got better and better at it. We've gotten so good the problem is that these organizations are optimized, in some cases, for the wrong thing. They're optimized for safety, for predictability, for preserving what exists, and as a result, these organizations are less likely to encounter anomalies and surprises, and the inefficiencies and mistakes that lead to learning and that lead to innovation. It's actually an interesting and ironic by-product of our proficiency at management that these organizations are simultaneously more capital efficient than ever before, but less capable of producing breakthrough innovation.
Ricky Mulvey: You said what do you do about it? From your work and your writing, it seems that for a lot of these big companies, the solution, and I think this has a direct tie to the investors listening, it's creating relationships with start-ups where they can have the firepower, the capital. You can be an owner of the company or an equity partner, but you can let them be inefficient and not have the committee-watching eyes of large institutions.
Elliott Parker: That's right. These organizations, these large corporations, need to find a way to enable and allow some deliberate inefficiency. Reed Hastings, the CEO of Netflix, stated it really well. He said, "Chaos, as long as its productive and fertile, will always be sterility." Large companies that are pursuing capital efficiency, if they overdo it, they become really sterile. Sterility is death. You need a little bit of chaos as long as that chaos is productive, and so how do you enable and allow that deliberate, efficient inefficiency into the system? You don't want to distract your operators. You want them to continue doing what they do really well. Capital efficiency is good to a point. I think engaging with start-ups for these corporations, whether that's through investment partnership or in some cases, building start-ups from scratch outside the corporation, can be a fantastic way to enable and allow some deliberate inefficiency into the system that then opens up the corporation to learn.
Ricky Mulvey: For a lot of stock investors listening right now, they hear mergers and acquisitions, they think about diworsification. A lot of the companies that paid up way too much money over the pandemic period for a lot of small companies, and you have your examples like Meta buying Instagram. But what's your advice to the investors who are listening to this and thinking: you know what, I don't like seeing the companies I own doing a lot of mergers and acquisitions. What should we be looking for when they're taking these stakes and start-ups? How should we be judging and evaluating those?
Elliott Parker: Here's, maybe, a counter-intuitive and perhaps a controversial idea. But my view is that these large corporations haven't really changed their approach over the last several decades when the outside environment has changed pretty dramatically. If you go back 100 years, Ronald Coase won a Nobel Prize for explaining why corporations exist. He said they exist to pull assets and resources into the corporation to manage the transactions between those inside the corporation and to do it at a lower cost than could be done outside the corporation. When you fast-forward 100 years and because of changes in the technology, communication, often the transaction costs, in other words, the ability for individuals and small teams to work and to craft deals, the transaction costs outside of corporations are quite often lower than they are inside. Corporations, in many cases, are still playing that old song which is bring it all inside. That's not necessarily the best way to do it. I think corporations need to understand that in a decentralized world and we are becoming more and more decentralized, the name of the game is coordinating outside resources to their advantage rather than trying to collect it all within the walls of the corporation. We use the analogy of an old medieval walled town was the old analogy for corporations. The new analogy is something much more porous.
Ricky Mulvey: Are there any large companies impressing you then with their ability to work with these start-ups and create these partnerships that allow them to innovate in ways that they couldn't inside their company?
Elliott Parker: I think Microsoft is a great example right now in terms of the experiments they're running through start-up engagement tapering investments, small investments, large investments, across the ecosystem as a way to create some learning back to the core business as well as some strategic optionality for the future. We tell corporations we work with all the time that in the face of an unknowable future, the best way to maximize returns and minimize risk is to run as many experiments as you can at the lowest possible cost per experiment. I look at those corporations that are really good at experimentation, and especially, experimentation outside of the walls of the corporation as being better positioned for that unknowable future that's coming really quickly.
Ricky Mulvey: Well, the example with Bing, the search engine. I forget how many experiments they ran. But they ran a bunch of them. Then what was it? 2% of the experiments end up driving a Parrado level of change for how their search engine improves.
Elliott Parker: Yeah, that's the thing. If you think about it, a corporation has to learn, they do that by gathering insights. You think about those insights as a power law asset where one or two insights can lead to dramatic change in the trajectory of a company. The problem is you don't know ahead of time which insights matter most. These corporations that are running lots of experiments gathering lots of insights are just mathematically better positioned to survive the future.
Ricky Mulvey: You're someone who's watched large corporations try to innovate, seen smaller organizations help them innovate. One thing that happens, and we see this a lot in presentations from big companies, is innovation theater. Where its something that might look like an innovation, but it's a small change that doesn't really matter. What are some flags to you? How do you spot innovation theater?
Elliott Parker: It's so prevalent, it's so common. When you look across corporations, what you often see is there's obviously a sense that we need to be innovating. We recognize that the business model needs to transform over time. Everybody knows about the innovator's dilemma. The thing that's ironic is we've gotten worse at addressing the innovator's dilemma over the last 30 years since Clayton Christensen wrote his book. The signals, I'd give you a good example. I once worked with a company that had a 200 plus person innovation team. They were investing over $50 million a year in renovation efforts. This is in the tons and tons of billion-dollar company. It's a large organization. But they're investing over $50 million a year in innovation. After seven years, that effort had not produced a single dollar of incremental revenue. Now they could point to places where they had saved some cost in the business. That's important, that's a really important type of innovation. But that's not what the team was set up to do. The team was set up to drive fundamental transformation in the business model. They obviously weren't doing that. It's so common. In fact, when you look across examples of large companies and when large businesses has successfully transformed their business model in the face of a changing future, they're really two paradigms.
You've got companies like IBM where maybe five or six transformations over their long history. In each case, it was driven by an existential threat. If the company didn't transform, they are going to go out of business. That's one paradigm. Companies back against the wall, they have to transform or they're going to die. Often, that transformation happens through M&A or some hail Mary type of acquisition. The other scenario is where you've got a founder still in place running the company. The founder, who is willing to take big swings, hasn't shifted to professional management yet. The founder is still there, company is generating cash. They're willing to make some big bets and try things. A good example that would be Amazon going into AWS, Netflix shipping DVDs to digital and TV production. Three stages of transformation. That is pretty rare. The hardest thing is for the companies that are doing relatively well, generating profits, professional management in place, not facing any extra existential dire threat yet. It's really hard to think of any examples of companies in that position that successfully transformed their business model. That should provide some fodder for thought for investors as they consider replacement bets.
Ricky Mulvey: This was also at a time where those companies were significantly smaller, at least by market cap, than they were today. I think right now it'd be really hard for Netflix to completely shift their business model again. If they needed to go away from streaming or some physical media thing, not that they would have to do that, but to make some transformational pivot. That's a lot more difficult when you have institutional investors and trillions of dollars of capital bet on your company.
Elliott Parker: End of shifts. Not to denigrate the professional managers running that company are incredibly capable and smart. But the founders aren't running the show anymore. They're in a much harder position to execute the next transformation. When you've got things like digital gaming, you've got AI generating new content in real-time. You've got global competition, much harder position than they've been in the past.
Ricky Mulvey: Yeah, I think there's a positive place. I think, like most people, my brain split between the positive and negative of artificial intelligence. But when we're talking about innovation theater, it's hard not to think about artificial intelligence right now. A lot of the companies that are absolutely rushing to get out of the gate to prove that they have something, anything, about AI transforming their business when maybe it's addressed up chat bot, maybe it's just something to show and have the buzzwords hit for the Control F people on the earnings cause.
Elliott Parker: If you think about the three ways large companies can use AI to drive transformation right now the business model. One is by increasing efficiency in their operations. Cutting out costs. Number 2 is improving the customer experience. Number 3 is creating entirely new business models that only are able to exist because of AI. You think about the first two corporations are positioned to do those first two things really well. We see examples of corporations doing that. They're now experimenting and using AI to reduce costs, improve customer experience. Those are great forms of innovation. The thing is that relying solely on those types of innovation is a path to going out of business. Because those things become table stakes. That third, creating entirely new business models, is what turns out to be really hard. Corporations are not optimized for that, which is why we see start-ups coming in and doing so much of it.
Ricky Mulvey: One of the things you've written about, as well is how corporate lifespans are getting shorter. Even though the companies are significantly bigger, there's more trillion-dollar companies right now than there were 10 years ago. I don't think there were trillion-dollar companies a few decades ago. Why is that? How do we know that these companies, essentially, honestly, this is a weird way of putting it, aren't functionally immortal? It's hard to think of a world without Amazon right now. It's hard to think of a world without Apple. Why do companies need lifespans the same way that living and breathing things do when they're not living? They're an organization.
Elliott Parker: Yeah. Amazon is a great example. I don't know if you remember this. A few years ago, when Jeff Bezos was still the CEO, he came out at a company meeting, I believe, and told the employees that Amazon would one day go out of business. This sparks a huge controversy. How could the CEO of Amazon say something like this? But, of course, he's right. Of course, Amazon one day will go out of business. What he explained to the employees of Amazon was that their job was to put off the demise of the company for as long as possible by continuously experimenting in the service of customer needs. As long as these corporations are able to experiment in the service of customer needs, finding better ways to help customers, they should continue to exist. When they stop doing that, they're not serving society as well as they ought to. They should be replaced by new upstarts that come in to take a hold and move out. Why are corporate lifespans shrinking? I think it's a signal that corporations are less capable of innovating than they used to be. Yes, competition is harder in a more globalized world. As we've talked about, more things are decentralized. You've got more power in the hands of individuals and small teams who now have access to more capital communication technology building blocks than they ever have before. It's much easier to start a new business than it's ever been. It's harder for corporations to compete. That's the irony. They've got more money on. There's more money on corporate balance sheets than ever in the history of the world. Yet corporate lifespans are shrinking. We see more share buybacks right now. There are plenty of good reasons to do share buybacks. But when we see them at the level at which they're happening in the market right now, I think it's a signal that, in many cases, corporations have lost their ability to dream big dreams and do big things. They don't know how to innovate as well as they once did.
Ricky Mulvey: You talk about these corporations that are built for longevity, built for endurance. You've got a timeline of them, of the longest-lasting corporations, going back to more than a few thousand years ago. But a lot of them that have come up in the past hundred years that we know on the US Stock Exchange, their financial, JPMorgan, Cigna, Citigroup. It's hard to think in the case of these huge financial institutions that I'll say in the case of JPMorgan Chase, it's hard to think of a version of the story where that company goes completely bankrupt and kaput, without the entire country of the United States going down along with it. Are those companies, when you look at that timeline are they even capable of being disrupted?
Elliott Parker: Hundred percent, they are. The theory would tell us that they are. In fact, when you think about Clayton Christensen's idea around disruptive innovation, what he said was, in a nutshell, what that theory says is executives can do everything right in their companies will inevitably go out of business. Buy everything right, meaning serve their best customers ever more profitably in the pursuit of capital efficiency, increasing return on invested capital. As they move up market to better address the needs of those most profitable customers, they leave themselves exposed at the low end. For new entrants to come in with good enough products and services, grab a foothold and eventually move up market themselves and displace the incumbents. It's a really hard problem to solve. The only way you solve it is by effectively disrupting yourself over time. There's organizations that aren't continuously running those forms of experimentation that challenge the status quo are, in fact, dying. The theory tells us that they're on their way down. It may not be obvious right now. It may take a long time. But the trend line is not moving in the right direction.
Ricky Mulvey: For those big, huge banks we're talking about, are you talking about corporations as a whole? Because I'm thinking about these.
Elliott Parker: I'm talking about all of them. You've got situations where you've got large banks where the government is stepping in and saying we're going to preserve this, that's going to exist them out as long as the United States of America exists, this has gone to exist. That's a different situation. We'll see. But even there, I would argue that even those organizations, at some point, have to be producing enough societal surplus for society to deem them worthy of continuing to exist. There may come a point where society says they're not producing enough surplus, even with government backing. It's a precarious position strategically to be in where you're, depending on the government to be there to support you. In the end, a government can change it's mind.
Ricky Mulvey: There's a lot of reasons companies say they go out of business. They got a business for one reason, that's because they run out of money. [laughs] One goal of the folks listening, they want to find those companies that can endure, they can exist, not go bankrupt for hundreds of years. What are some signs then that one is looking at a company that's built for endurance?
Elliott Parker: Yeah, such a good question. I think this is a fascinating topic because as you alluded to, there are companies in operation today that have been in existence for over a 1,000 years. The oldest company in the world was founded 100 years after the fall of the Roman Empire. Construction company in Japan that was just acquired in the last 25 years. I think all the time about the guy who was managing that business when it ultimately succumbed, right after 70 generations of family ownership, stress you must have felt.
Ricky Mulvey: That's tough one.
Elliott Parker: But, I don't know about you, but I love the idea that an individual can start something that endures for 1,500 years and helps solve problems for that long. That isn't amazing thing, I want to do that. When you look at these organizations and what they all have in common there many features that they have in common, but what it really boils down to is what Jeff Bezos told his employees at Amazon. Your job is to prolong the demise of this company for as long as possible by continuously experimenting in the service customer needs. Now what these really long lived organizations have that's different is they are continuously thinking not only about their current stakeholders and customers, owners, society, they're thinking about the stakeholders past, present, and future. This is a longer timeline. There's a company in Japan during COVID, a Researcher was looking at some of these companies in Japan that had been around for a long time and asked them, are you going to be OK during COVID, do you have enough in reserves to be able to survive the crisis? That's a common consensus was that look, a big crisis comes every decade or so. We've been in existence for hundreds of years. We plan for this. One business told the researcher they had enough capital on hand to last for 17 years without revenue. That's like a degree of safety that's probably beyond what's necessary, but it's an interesting perspective. They're thinking about past, present, and future over long periods of time. What they're going to pass on to future generations. They're thinking about what it means to be a good ancestor. I think that the world would be in a better place if more executives were thinking that way, it's a hard thing to do. But it's a contrarian view right now, having that long-term perspective. If you want to win in business, the trick is over time, you've gotta be non-consensus contrarian and turn out to be right. If you're going along with the consensus and you're right, you will go out of business. You need to find ways to be non-consensus, to be contrarian and turn out to be right. Right now, a really easy way to be contrary and er, non-consensus is to have a long-term view, to be optimistic about the future, which right now uniquely in the last couple of decades, it's also contrarian to be an optimist. A couple of easy ways to be contrarian and to turn out to be right.
Ricky Mulvey: Well, one of the things when you're talking about the basically cash without revenue, Berkshire Hathaway is an example of a company like that where they have tremendous amounts of cash on their balance sheet, relatively lean as an operating company and a lot of investors have, what are you doing with all that cash? It's that extreme long-term vision of the late Munger and Buffett have allowed them to pull that off in many ways and not listen to those outside voices.
Elliott Parker: If you go to the opposite, go to the alternative, which is a company, I went to business school that we learned that as an executive, your goal is to push for monopoly status. That's how you extract most profits and winning and business is to achieve monopoly status. Knock out all your competitors. Monopolies don't endure. Right there. They're overdoing it. They might benefit over a short period of time from maximum profits. But when you look at the long arc of time and total profitability under the curve, over decades, over centuries, they're not performing as well as some of these organizations that are taking a more careful approach. Again, I think that's an interesting thing to consider for investors who are looking at companies, they wanna be placing bets.
Ricky Mulvey: Why do you think that is? I think about a utility company, which for a lot of people that's not the worst place to place a bet, you get a high dividend, you have a relatively steady return. That's a monopoly and it seemed to do OK for, for quite a number of people.
Elliott Parker: I think that maybe it's interesting question. It's one to dig into more and do more research on. In the end, I would say that that's a monopoly that is constrained in our ability to maximize profits. They're still producing societal surplus. Society is looking at that saying, We will allow you to continue to operate with this model because we benefit the problem you run into with companies where they're extracting too much profit is society then says through lots of these, through government intervention, through other ways, We don't want you to do this anymore and we're going to shut you down and we're going to constrain your ability to operate in the way you have in the past.
Ricky Mulvey: It's, it's constrained versus unconstrained monopolies. That might be playing out with Ticketmaster right now with the antitrust suit they got. We'll see if anything happens there. One of the things that is going to be a little controversial for some of those listening is also your beef with return on invested capital. In business school,[laughs] that's a metric that everybody loves. Hey, a lot of market beaters over a long period of time have a high return on invested capital. You seem to have beef with this specific investing metric. Why is that Elliot? Why the hard feelings.[laughs]
Elliott Parker: Return on invested capital is not a bad thing in and of itself, but I think companies can overdo it. The way that this manifests itself in corporations is companies being overly careful trying to eradicate variance from the system entirely. If you go back, I think it was in the 1980s, Jack Welch was the CEO of GE and famously said variance is evil. What he meant by that was job with the leadership team at GE was to root out any possible error making. We wanna make things as predictable as safe as possible and preserve what we've got. Well, the reality is that people don't thrive in a system like that, that is so hyper-efficient. Also when crises come, those systems turn out to be pretty fragile. We saw a lot of this during COVID with supply chains. You have these amazing, incredibly capital-efficient, high ROIC supply chain operations. When one piece in that system broke, the whole thing would crash down. Yes, in the initial quarter, that might've been very capital efficient, but over time, when the thing breaks, it turns out to not be efficient at all. ROIC is good. What I would question is the time period over which we're applying the metric. The problem is that the incentives all drive managers right now again, to be focused on that near-term output. It produces really fragile companies that don't endure and don't produce over long time periods, sustainable returns.
Ricky Mulvey: But over a long time period, it seems from the data I've looked at companies with a high return on invested capital tend to outperform the market.
Elliott Parker: It may be a question of what's the optimal ROIC. Again, I think that it just can be overdone. When you think about capital efficiency drives ROIC, what's the appropriate amount of capital efficiency? There has to be some inefficiency in the system. For organizations that are trying to route it out entirely, those organizations are going to fail to learn. A100 percent capital efficient organization doesn't learn. They're really good at executing and operating. As long as the world stays static, that's fine. But as the situation changes and it inevitably will, that corporation is going to find that they're not positioned to endure and survive the shift.
Ricky Mulvey: Maybe it's different. I think if you have a young innovative company, ROIC is not a great metric because you don't have that time horizon. If you have an older mature company, Home Depot's the example I'm going to use, maybe ROIC is a good metric for the next, I would say 10 years. It's going to be intensely difficult to disrupt the Lowe's Home Depot duopoly, in which case we're going to transform into a cash cow and reward our shareholders because we have the business down and we're not going to fundamentally change. We also know that 10-20 years from now people are going to need to go to a big store because they can't figure out, myself included, what exactly size screw I need to put into this picture frame.
Elliott Parker: Maybe. It's hard to predict the future, is what I would say to that. There have been plenty of situations that looked stable and turned out not to be. But I think there are certain situations where you look at a company, say, yeah, they've got a pretty stable position. Innovation's not so important. The managers should just be managing this thing for cash. But what you have to do is recognize the trade-off. The trade-off is that when the disruption comes, they're going to crash pretty quickly. They're not going to be ready at all. The argument is in that situation is that a company that needs to endure or is that a company that should just manage it for cash and say, hey, where over the next 10 years we're going extract as much capital out of this thing we can? That's a fine strategy. The problem most companies make is they find themselves somewhere in the middle. This is the illusion of innovation. It's, well, we need to be innovative. We're going to pursue activities that look like we're doing important things but don't produce any meaningful output. There are plenty of companies in situations that where it's really the best strategy would've been just manage it for cash, manage that downturn. Famous story is Kodak, how much money they spent at the end of that company's life focused on last-ditch effort and innovation. In retrospect, they should have just manage that thing for cash. Again, that goes against all human nature, that's very hard to do. But there are situations where it does make sense to do that.
Mary Long: As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow.
Citigroup is an advertising partner of The Ascent, a Motley Fool company. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Mary Long has no position in any of the stocks mentioned. Ricky Mulvey has positions in Home Depot, Meta Platforms, and Netflix. The Motley Fool has positions in and recommends Amazon, Apple, Berkshire Hathaway, Home Depot, JPMorgan Chase, Meta Platforms, Microsoft, and Netflix. The Motley Fool recommends International Business Machines and Lowe's Companies and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
