Cash reserves, risks and innovation

In my last post I discussed the large cash reserves that companies have been holding since the 2007 recession. As I mentioned there are several reasons for this, some of it has to do with lack of R&D investment. R&D is an expensive investment. This requires both train scientists and equipment to conduct the research. In addition there are extra requirements for technicians and other employees to support the R&D effort. This isn’t cheap. As we can see in the bottom half of the chart all types of research funding has decreased recently.

R&D is not a certain thing by any stretch of the imagination. This is why companies are paring with universities to share the burden of R&D. Universities are doing much of the basic and applied research, while industry is developing it into product. This is where the money is and the greatest amount of certainty. You can’t really blame companies for this, but they need to work to develop their own technologies regardless of the work being performed at universities. To compensate many companies do engage in corporate venturing. This is where they fund a start up to conduct research and get a product to a certain position and possibly buy that company after a certain maturity point, set up an exclusive license or license the technology once it’s mature. This reduces the large company’s risk exposure.

The final piece that has increased since the late 80’s has been the amount of litigation due to patent infringement. In 2011 the amount of money spent on patent litigation was $29 Billion. That is a lot of money. That’s a quarter of the money that Apple has in it’s reserves. We also know that Apple is one of the largest spenders on litigation. I know there are a lot of Apple lovers out there, but they could have invested that money into more products and reduced their risk of a flop with the next iPhone. We all know that iOS6 was a major disappointment for many people, spreading their revenue stream into more sources with some cool research could mitigate any fall out from that or if iOS7 is more of the same. 

Litigation is such an outsized risk because it can lead to your entire firm being shut down by a non-producing entity. This reduces the incentives for innovation and increases the incentives for hoarding cash.

Business Cash Reserves and Innovation

I found an article on MarketWatch that discussed the fact that the private sector is, in fact, doing just fine. As the author mentioned, this didn’t go over very well whenever Obama mentioned it a few weeks ago. However, he’s right. Companies as a whole are doing extraordinarily well (see graph below), but normal people aren’t seeing it. I’ve discussed this before in a Future of Employment post.

As you can see from the graph Corporate profits are at an all time high. We also know that investments are still occurring in new equipment. We know from the numbers that companies aren’t hiring. I think that the GOP would argue that this is because of regulation uncertainty, which they are contributing to. From what I’ve seen the Democrats don’t really have any sort of good explanation for the lack of hiring. The author of the MarketWatch article claims that companies aren’t spending money on new employees because they are returning most of it to stock holders through dividends or stock buybacks. The data supports this perspective to some extent. Part of it could be the fact that many companies are automating, outsourcing and offshoring all contribute to some level or another.

I think that it’s a combination of these factors plus one other factor. This was added as something as a throw away at the end of the article, but it really stuck with me. “Corporations may be intensely profitable, but they have no profitable ideas about what to do with the vast sums they earn.” This comment is extremely important, especially when you couple that with the article that the Washington Post just published about the difficulty of PhDs finding jobs. 

These researchers are the core of the future for innovation at companies. If companies aren’t hiring these scientists, despite the fact that many claim there are skill gaps, then they are unlikely to innovate moving forward. My old roommate in the Netherlands, Brian, told me that the Holst Centre where he worked created 3 jobs for every employee at their research center. I’ve seen similar numbers in one of my courses as well. 

In this case the trickle down effect actually works. You hire researchers and they need to have technicians building equipment, which needs to order parts and raw materials to build those components. Which requires additional labor elsewhere. While 3 for 1 may not seem like the greatest ratio, those other workers typically make good money and will end up spending money elsewhere.

Innovation drives the economy. Companies need to look at how they manage risk, especially if they are sitting on huge reserves of cash. Putting more money into research for their field can lead to huge disruptions in technology and could lead to an increase in market share.

I will talk more about these risks in my next blog.

Climate change more than melting ice caps

Yesterday I heard a report on NPR about how climate change is interacting with natural wild fires. I found an article about the paper, which was published originally in Ecosphere, which discusses some of the long term impacts of the climate change on wild fires. To do this, the group used 16 different climate models which ranged from very favorable emission numbers to catastrophic emissions numbers. This allowed for a wide range of different types of human activities and reflective climate changes in the area to be tested. This is important as it gives the article much more validity than if they had simply decided to use the worst case, or best case. Of course, there will be people that will argue that man has nothing to do with the climate and we aren’t impacting it. However, that’s sticking your head in the sand. We know we have impacted the climate in the past (hello Acid Rain) and have actually fixed it though changing our behavior (Acid Rain again).

Just using the climate models isn’t enough to really predict how and where wildfires will occur in the future. The wild fire itself had to be modeled as something where the conditions it could exist in can be tested. The group decided to model wild fire in the same way that movement of animals are modeled. Under certain circumstances it’s likely that an animal group will move into a specific type of environment. This is based on the amount of water, the amount of vegetation and the temperature. Wildfires need the exact same resources to exist. However instead of being lush and moist, the area needs to be dry, but with enough water to have had plant growth to a certain size.

By combing the two techniques the team was able to show that the West is going to be burning a lot more frequently than they are not. This of course creates a serious problem. People like to live in those areas. People don’t like to leave their houses when there are disasters, which means that we’re going to have more people burning, like the one in Colorado.

The authors, in the NPR interview, argued that this means we need to learn how to live with wildfire in the same way that we’ve learned how to live with floods and earthquakes. How can we do that though? It is likely to be more difficult than flooding because you can’t just build a mound of dirt as a ridge to prevent fire from moving further. With water you can do this with varying success. With fire, that mound of dirt will eventually grow grass on the mound and would just as easily catch fire. Even stone walls would be passable as a strong wind could blow embers over the wall or heat the wall to the point of material catching on the other side.

These are issues that we will have to resolve in the next 10-30 years. This seems like a long way off, but time has a habit of sneaking up on you and before you know it we’ll be having wildfires like we had in Texas last year and are having in Colorado and New Mexico now. I’m glad we’re aware of the extent of the risk now though.