Are we entering an era of stalled innovation?
Firstly, a quick disclaimer — I very much dislike the term “innovation” as it is an over used marketing term these days with no consistent meaning in the real world. So, for the purposes of this article, “innovation” will be referring to technology and software based innovation. On to answering the question…
Over the past decade we have seen significant innovation in software and technology. This has, in no small part, been fuelled by investors and venture capitalists throwing money at any and every potential idea in the hopes of sizeable returns on capital in an age of historically low interest rates.
Since the great recession, record low interest rates were set by central banks with the objective of spurring investment activities. One of these activities has been betting on start-ups. To date investing in start-ups has been one of the few options that could produce significantly high returns, especially if the start-ups go public with an IPO.
The theoretical approach taken by venture capitalists and other investors can be summarised as follows: invest in as many innovative start-ups as possible, with the hopes of a handful making it big and covering the losses on the rest with a healthy profit left over.
Forward to 2022, rampant global inflation is now forcing central banks to increase interest rates faster than anticipated. With rising rates, investors will be more cautious when allocating their capital, and likely change, reduce, or stop their current strategy of throwing money at any and all start-ups that claim to be innovative.
This change should not be viewed negatively for innovation but instead should be welcomed by those who offer a genuinely innovative product or solution as it will naturally weed out lesser competitors.
In the past decade we have seen an increase in the bad as well as the good in the name of innovation. With the bad, in some cases, being very bad (think Theranos and Nikola). These two companies are the perfect case studies illustrating what is wrong with the throw cheap money at anything approach.
With their respective charismatic leaders at the helm, Theranos and Nikola arguably executed two of the biggest frauds of the past decade. Significant bets were made on the promises of these “innovative companies”, largely due to the availability of cheap capital.
These bets were seemingly made with little rigorous due diligence. After-all, what was the alternative investment? Leaving cash at the bank for a negative three per cent real return? No self respecting VC would opt for that.
To this end, an argument can be made for cheap capital polluting innovation — at its best it resulted in ludicrous valuations and at its worst, supported fraudsters.
So, where does this leave us as we enter this new era or high inflation and interest rates? Well, innovation will not stall. It may reduce temporarily as companies refocus resources on core capabilities that provide secure profits, but it will not stall.
Why won’t innovation stall?
Simple, innovation happens challenges need to be overcome, and challenges will not stop simply because interest rates have increased.
Instead, what we are likely to see as we enter this new era is a recalibration of investors’ mindset and approach, one where they will more carefully place their bets, and nurture each investment as there will be fewer of them.
We will also likely move away from the exuberant valuations that have weighed down companies with unrealistic growth expectations, and instead shift to a back to basics approach of growth through sustainable profits.
These coming shifts will have a net positive impact for true innovation.