Despite the fact that executives could improve the value and performance of their companies by shifting capital from under-performing business units to better performing units, most choose to allocate their resources the same way year after year. More troubling, our own research shows that even when business leaders are proactive resource allocators, they are still hesitant to invest in new business models. As technology continues to change and challenge even the most successful incumbent organizations in every industry, the cost of inertia is growing.
Despite the shift to intangible Assets, executives and their strategists are sticking to the status quo. It is easy to understand why this is the case. According to our research at the SEI Center for Advanced Studies in Management, it’s the beliefs of leaders that drive organizational investments, board selection, and management team development and selection, and these beliefs do not change quickly. Outdated beliefs about the world can linger for decades in a leadership team. Further, it simpler and less risky for managers tend to stick closely to the previous year’s budget.
There is also the issue of politics — including at the board- management-team levels. Even if a leader is confident that investing capital in digital transformation will help the company as a whole, most managers are hesitant to take the chance on something new for fear that their performance will take a hit in the short run and spook investors — or customers and employees.
In our experience, there are other causes as well. Since many corporate leaders began their careers when physical stuff dominated business, they often view intangible assets as risky, overvalued, and difficult to manage. Thus, despite the incredible potential of intangible assets, like data and networks, most leaders keep funneling capital to plant, property, and equipment rather than shifting it into more valuable assets — intangibles that are supported by platforms and networks.
In short, leaders today need to master a new and missing skill: capital allocation. Remarkably, capital allocation is not something that leaders are taught on the job or in business school despite its importance. But as Warren Buffet has observed, “Once [leaders] become CEOs, they face new responsibilities. They now must make capital allocation decisions, a critical job that they may have never tackled and that is not easily mastered.” Buffet mused that expecting a new CEO to make proper resource decisions is akin to thinking that a concert violinist could flourish as the Chairman of the Federal Reserve.
Finally, Generally Accepted Accounting Principles (GAAP) used to manage businesses and report to investors often ignore intangible assets or miscategorize them as expenses. And even though some managers do track intangible assets, they’re usually one-off metrics or unique to a particular division; they’re not systematic or incorporated into the entire business’s capital allocation decisions. Therefore, it’s difficult for leaders in companies filled with legacy physical assets to shake off years of experience while shifting investments toward newer, and more scalable, asset classes.
Given those challenges, if you currently allocate resources as part of your yearly budgeting process, it’s important to evaluate yourself, critique yourself, and try to overcome your proclivity for inertia. You can start by determining what type of resource allocator you are based on your investment preferences – tangible or intangible – and your approaches to re-allocation — reactive or proactive. (You can take our online leadership investment style assessment)
- Reactors take a conservative approach to capital allocation and prefer physical assets. These leaders often head legacy companies that have long histories in physical industries. They do not value intangibles and only reallocate capital when the market forces their hand.
- Transformers prefer owning and managing tangible assets, but are more open to reallocating capital. Transformers are willing to make changes within their organization, but aren’t able to shift to the most transformative, intangible assets.
- Alignors value and prefer intangible assets, such as software, knowledge, data, and relationships. These leaders often “grew up” in digital industries. However, Alignors tend to stick with industry norms, despite their preferences and the rapid advancement in digital technologies.
- Disrupters value intangible assets and see to actively reallocate capital in response to the latest data and market trends. These leaders are able to capitalize on the valuable digital assets (networks, platforms, software, data, etc.) that the market prefers today, but also are ready and willing to shift asset allocation when the market evolves.
Once you candidly assess your own inclinations, reflect on your core beliefs about what creates value at your company. Then think about what you and your colleagues might be overlooking because of outdated accounting methods.
Although physical assets and the same yearly budgets may be working for you now, neither will help you or your company stay competitive and relevant in today’s digital-driven market.