Clearing Innovation Obstacles

For much of its history, Canada has underperformed in business innovation in relation to the world’s leading economies. For several years, Canada has remained near the bottom of its peer group on innovation as noted in The Conference Board of Canada’s How Canada Performs Innovation Report Card, released in December.

Canadian attitudes toward risk are often cited as a one of the biggest obstacles to Canadian innovation, with Canadians often described as conservative or risk averse. So what has risk got to do with innovation?

The Conference Board of Canada’s Centre for Business Innovation conducted a national phone survey to examine Canadian businesses’ attitudes towards risk and whether or not these actually affect business innovation. (The survey considered the topic from three perspectives: the risk-taking attitudes of Canadian business people; risk aversion as managerial constraint; and the risk-taking skills of Canadian employees, all three of which play a role in Canadian companies’ approach to risk.)

ASSESSING RISK TOLERANCE

To assess risk tolerance, each surveyed Canadian business was asked to imagine its company has $100,000 to invest in innovation. Given the best- and worst-case returns of the four choices below, which would the leadership choose?

$200,000 gain or $0 gain/loss;

$800,000 return or $200,000 loss;

$2.6 million return or $800,000 loss; and

$4.8 million return or $2.4 million loss.

This question is designed to determine how large an investment the respondent thinks his or her company would make to achieve a specified return or a possible loss. The potential loss is geared to the gain, as it is in financial markets.

Of the 1,100 responses, 90.5% were from small businesses (under $25 million), 6.4% were from medium-sized businesses ($25 million and over, but less than $75 million) and 3.1% were from large organizations ($75 million and over). In about 80% of the cases, responses were from either the owner/manager or the president of the company (i.e., the one who should be in the best position to judge the risk tolerance of the company leadership).

WHAT THE RESULTS SHOW

At first glance, the results appear to provide evidence for risk aversion by Canadian businesses, with almost half of the businesses choosing the most conservative wager. Another 35% would take the second most conservative wager.

There is a 1 in 17 chance that a Canadian company makes the big bet.

However, when examining attitudes towards risk, it is important to take into account the ability of the company to take risk and absorb losses. Three questions are important to achieve a true assessment of risk.

First, how much money does a company have to lose? The Warren Buffetts of the world may consider the $2.4 million loss posed in the survey question to be little more than pocket change; yet, it would spell corporate ruin for many small businesses.

Second, whose money is being put at risk? The leadership of smaller companies tends to be the same as the owner who assumes the financial risk. As companies become larger, their capital structures become more complex, and owners may be a different group of people than senior management.

As such, the risk-takers are different than the risk managers. The managers are not actually personally at risk.

Third, how are the theoretical responses likely to relate to the actual business practices of the respondents? It is easy for someone to answer a theoretical question, but what is the likelihood that his or her survey answer reflects that person’s actual risk management?

To shed light on these issues, the survey compared the respondent’s answers on risk tolerance to 2013 sales. It used sales as an indication of company size and the capacity to absorb losses in the event that the $100,000 innovation wager does not work out as planned.

About half of the survey respondents were companies with sales of less than $1 million. These companies would be hard-pressed to make a $100,000 wager on an innovation project without some outside funding. And they are most assuredly not in a position to absorb significant losses on their own accounts.

Data suggests a clear alignment between risk-taking and a business’ financial capacity. More than 70% of surveyed Canadian businesses are realists in terms of aligning their risk-taking and financial capacity.

However, about 10% of Canadian firms (just over 100,000) assume smaller risks than would be suggested by the scale of their operations. These companies are truly risk averse.

A somewhat smaller group (about 4% of respondents) are described as “wishful-thinkers” because their risk tolerance exceeds their capacity to absorb losses.

Finally, about 15% of polled companies are risk-taking “leaders” that both take significant risk and have the financial wherewithal to assume those risks.

WILLING, BUT UNABLE

Canadian businesses are willing to take risks – the problem is that they have limited financial means to absorb potential losses. The vast majority of businesses have aligned their risk-taking with their limited financial means. They may also be avoiding risk because they can succeed on some level without it.

This nuanced way of looking at the relationship between risk tolerance and innovation leads to somewhat different conclusions than analyses that assume all Canadian businesses are risk averse or, alternatively, that Canadians (either privately or publicly) should fund businesses with the greatest risk appetite.

To improve Canada’s innovation performance, the number of Canadian businesses willing to take significant risks and that have the financial capacity to absorb losses must increase.

An improvement in risk-taking by Canadian business involves addressing the specific issues of each of these groups. For the risk averse, it is about encouraging them to be more risk-taking. The realists simply need to scale up their businesses so they can take more risk. And the wishful-thinkers need to convince outside parties, usually venture capitalists and angels, to fund their risks.

By making changes to leadership, management or corporate culture, risk-averse businesses could better position themselves to take more chances.

What are the top-ranked innovation constraints?

The survey found that the top barriers to innovation are regulations, lack of financing and time, lack of employee skills, and management. Leadership and organizational culture ranked low on the list of barriers.

Dealing with the top-rated innovation constraints would help Canadian businesses embrace more risk-taking and greater innovative activity.