Innovation in a Downturn
Helen Mallovy Hicks
Chris Dulny, a partner in the Assurance and Advisory Services Group of PwC, tallks about how crucial it is for technology companies to keep investing in innovation, especially during troubled financial times.
Dean: Welcome to Strategy Talks with Dean and Helen, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I’m Dean Mullett, co-head of our Restructuring and Distress Strategy Group, and a member of our Credit Crisis Task Force.
Helen: And I’m Helen Mallovy Hicks, a Partner in the Advisory Practice of PricewaterhouseCoopers in the Dispute Analysis & Valuations group.
Dean: The current state of the economy is understandably of great concern for most Canadian businesses. This series of audio podcast discussions with a variety of subject matter and industry guests are designed to help your business weather the storm by exploring some of today’s hottest issues related to the economic crisis.
Dean: In today’s episode, Innovation in a Downturn, are joined by Chris Dulny, a partner in the Assurance and Advisory Services group of PwC. He will help shed some light on just how the economic downturn is affecting technology companies and what might be different this time. Welcome, Chris.
Chris: Thanks Dean.
Helen: So tell us, how are technology companies faring in the current economic environment?
Chris: Well technology companies are seeing difficulties just like all companies are seeing. Perhaps not to the extent we’re seeing in the manufacturing and service sector, but this economy is still producing some challenging times. There’s still a lot of opportunities for tech companies that innovate. At the end of the day, opportunities available for companies who do it right have a great product or service and are producing something that is really relevant to the end user. And that’s the key here. Success in this time really depends on the ability to refocus on and understand your customer. Successful tech companies still have a lot of opportunity today.
Companies who get it right focus on their great products and really focus on the customer in terms of understanding them and understanding what they need. I think there’s a real need for innovation. Even in this downturn, CEOs and CFOs are still focused on driving efficiency. If fact, a recent PricewaterhouseCoopers survey said that 80 percent of CEOs surveyed around the world said that innovation was not only important, it was critical. And that’s what’s different in the technology industry. These are product offerings that help with efficiency, get information across in a much better way, and although there is a high level of caution in this current environment, people are still focused on driving innovation.
Dean: Having gone through that dot com boom and bust back in the early 2000’s, do you think lessons learned there have positioned technologies companies to be better prepared this time around?
Chris: I think in general, yes, and that preparedness comes from a number of different sources. I think there’s a different model that’s always been relevant in the technology industry. Tech companies have always had to move faster, they’ve had to be more agile to the changes in their industry, and they’ve always been operating on the edge. In a fact, the tech company is a global competitor right at product launch. There’s no insular borders they’re having to deal with.
They’re operating a large global scale as soon as they’re out there. Companies that survived the dot com bust learned some valuable lessons about being nimble and responding to the market. But it’s not only business practices, it’s financially as well. There’s countless examples of tech companies out there right now who have a lot of cash, who have little or no debt, and that discipline really was born of a bust. And they’re well positioned in this market.
Dean: So Helen, that question you asked about manufacturing versus tech companies. I think that’s probably the big difference. Their capital structure is very different.
Dean: And so they don’t have their lenders, and as we’ve talked with previous guests, getting some nervous lenders and trying to manage them in this environment makes one less stakeholder that you have to really take charge of.
Chris: That’s absolutely right; I mean there are some differences this time around. In the dot com bust, it was the tech companies that were hurting. But throughout the chain, tech companies executives see everybody is feeling some of that pain, whether they’re the people who are providing financing, suppliers or customers, it’s everywhere.
Helen: Chris, there’s a lot of talk about stimulus programs and cash infusion for struggling industries. I know we’ve certainly been talking, Dean and I, with our other partners on Strategy Talks about these issues. In the tech industry, the VC funding model is well-established. In the current downturn, are technology companies in Canada still funding their businesses through VC’s?
Chris: Well the VC industry here and in the US is facing some significant challenges. Venture-backed IPOs are at thirty year lows and any VCs you’re talking to today are talking about IPOs possibly in 2010 but probably beyond. Although, there is a lot of discussion about M&A being a viable alternative, at the end of the day, the M&A pricing in the market is kind of driven by the option to do the IPO, which isn’t there.
Chris: So it’s not as attractive today. At the same time, institutional investors have drawn away from the VCs because they haven’t seen the returns over the last number of years.
Dean: So why do you think investors are backing away from VCs. The returns have not been there, so has it not been a good investment spear for them?
Chris: Well I think it’s just been a shift over time over the last number of years. We’ve seen money move out of the VC environment into private equity and that’s what we’ve seen in the last three or four years, so with just the capital in Canada anyway has not been there to drive significant advances.
Dean: So the capital has been redeployed to another area?
Chris: Yes, we have seen some US VC activity in Canada, but there are a great number of excellent small tech companies who’ve been frustrated over time by attracting US VC investment. Either they’re too small, or the need of the US VC to be close to their investment has made it difficult to operate with US VCs.
Helen: Well maybe it’s also the nature of tech companies. Smaller tech companies tend to be riskier, and the M&A and IPO markets have been so hot of late that there’s been no need to invest in the smaller, risky growth opportunity when such great returns have been made in a more mature marketplace with lower risk.
Chris: Most people miss the risk of those mature assets as well, and then it got ‘whooo’, right?
Helen: That’s right.
Dean: Just like the bust and boom of the dot com. Everybody always missed the risk. Always invest where no one else is.
Helen: Well, and people were counting on hot M&A markets to get them out of their investments at the great returns and those markets have now dried up.
Dean: Chris, R&D is a major part of the technology, and obviously a very expensive part. With budgets and profits leaner, how can companies continue to grow and weather the storm?
Chris: R&D can be a significant investment of money and resources. It can be a long term proposition, and it’s difficult to measure what that return is in the short term. But R&D does not always equal innovation. Innovation is more about ideas and new ways to approach challenges and it can happen in many forms and not just with the introduction of a new product. Technology companies who look to ways to innovate in this economy will be the ones who are not only standing after the downturn, but will be well positioned to take advantage of growth opportunities as the upturn comes back.
Helen: Innovation and ideas. When companies are focused on keeping their customers happy, or simply keeping their customers, how can you focus on innovation?
Chris: What you have to remember that customers are actually a really good place to start. There’s no better time to get closer to your customers than now. In the past, people would say that tech companies were guilty of focusing on some flashy feature or a solution that customers didn’t even know they needed. But right now I think it’s important for tech companies to focus on addressing the true needs of their clients…on addressing that need of the CEO to become more efficient and more effective and to drive that innovation. So it’s all about creating a solution for a problem that exists, instead of dreaming up a solution for something that customers don’t even know they have to deal with. Everybody knows that it’s hard to get a new customer on board. We instinctively understand that you should spend equal, if not more time, on nurturing the clients you already have, and now is the time to look at innovative ways of doing that.
Dean: Companies around the world right now are rethinking every dollar that they spend and they’re looking to really find the impactful dollars and immediacy. How do you do that with innovation?
Chris: Well I think it’s all about looking at how you spend and perhaps introducing some control and structure to your R&D and your innovation programs. There is the concept out there that if you take a great idea and slap controls and structure onto it, you just suck the life out of it. But I don’t really know if that’s true. At the end of the day, all great ideas don’t come from a blank slate or a complete misunderstanding of what the problem is. If someone asks you to build a product that does x, y and z, that fits in the palm of your hand and weighs less than a pound, you have an interesting target to shoot for. And it’s the same thing with controls and structures. In reality, for those who are out there looking for financing, those providing the financing are going to look for that discipline in your business plan so it’s all about coming up with KPIs (key performance indicators) to keep on top of what you’re doing and to plan your future expenditures.
Helen: So Chris, who gets it right? Are there examples of Canadian industry initiatives or others that are still providing opportunities and going in the right direction?
Chris: Well looking ahead there are a lot of opportunities in Canada in the long term in the technology industry. There’s complete shifts in society that are happening right now: The socialization of everything, the clean tech initiative, and the digital and mobile revolutions. But the digital revolution is probably the greatest opportunity we’re seeing. A recent PwC report estimated that the global media sector and the digital content that will be part of that will see double digit growth and be over two trillion dollar market in the next five years. Canada has to be well positioned to be an important piece of this global shift.
And there are some great initiatives right now such as the corridor for advancing digital media, which is an initiative supported by multiple levels of government, the University of Waterloo, and Canadian leaders like OpenText. The corridor, of which the Stratford Institute will be a part will look to link digital media experts, researchers and entrepreneurs from around Canada as they continue to work on these problems. It’s a great example of how a number of different sectors in Canada are contributing to great opportunities in the future. PricewaterhouseCoopers is a collaborator with the institute. In Stratford, as well as the corridor. It’s a great opportunity of how a number of different sectors and players, including PricewaterhouseCoopers, are contributing to a great opportunity for Canadian entrepreneurs.
Dean: Chris, our time is just about up here today. In today’s risk adverse environment, what are some takeaways, some key quick steps that companies can take to kick start innovation?
Chris: Well it’s true that companies really want to innovate, be efficient and drive effectiveness throughout their organization. It’s more important than ever to stay close to your customers, talk to them, solicit their ideas, and consider using their content. If you take the time to understand at a deep level about why and how people use your products, the customers will lead you to success and not the other way around. What companies have to do is focus on ways to help their customer make money or solve a problem they’re already dealing with, instead of introducing something for a problem they don’t even know exists. One of the interesting things that we’re working with on technology companies, especially those who sell software, is looking at revenue streams, and making sure those revenue streams are complete. PricewaterhouseCoopers, by using licensing management software can assist companies in determining whether they’re obtaining all the funds they’re owed on their licensing deals.
Helen: And I imagine that’s really important in these times where companies are looking everywhere for cash, and that could be a really significant initiative to find more money.
Chris: It absolutely is. I mean, licenses can get out of control within companies and it’s difficult to know if you’re being paid for all the seats you’ve set up by the customer. And there’s a flip side to it and this is what we’re seeing at our tech clients. We can apply that technology inwardly as well, so that for their own licenses on which they’re a customer, we can say to clients, “you’re not paying for certain obligations.” In that case, and it’s a bit of a cost cutting measure, but in that case it’s an opportunity to go work with a supplier and come to a solution before they come knocking on your door looking for those extra seat revenues.
Helen: Are you finding that technology companies are having to reopen their agreements with their customers?
Chris: Somewhat, and I think that it always happens in an economy like this and everybody’s looking for ways to reduce costs. We’ve been in the market helping licensors finding those other streams of revenue. But the great opportunity in this case as well (and this ties in to the increased litigation risk in this troubled economy), is helping the licensee themselves understand how many seats they’re on the hook for, what they should be paying, and it gives them an opportunity to go work with their supplies to determine the proper solution. If we find situations where payments haven’t been up to the full obligation.
Helen: Or payments are beyond the full obligation.
Helen: Are we finding that there are opportunities for them to rationalize their contracts and pay more efficiently?
Chris: Yes, I think that’s right, and I think it comes back to introducing some of the control and structure about all your inflows and outflows. There’s definitely opportunities we’ve seen where it’s evident that growth has just happened over the last number of years, contracting has happened and now with a second look, there’s opportunities to reign in some of those costs.
Helen: Chris, one last question. Can you tell us how we are helping clients in the technology space at PwC?
Chris: Well at PricewaterhouseCoopers we have been dedicated to the technology space for a number of years. And that comes in a bunch of different forms. Number one, we’re a Canadian practice and we deal with Canadian problems. Although we have links to our US counterparts, we’re really focused on Canadian tech companies. Part of that initiative lies in our companies with extraordinary potential initiative where we have professionals with diverse backgrounds helping small companies grow and be successful. Part of our dedication to the technology space is our investment in growing companies. Working with them side by side as they grow, offering professional advice on a cost effective basis to ensure their future success.
Dean: Chris, thank you for your simple, honest and practical insights here today and for being a guest on PwC’s Strategy Talks.
Helen: Yes, thank you very much Chris, and for more information download the facts sheet ‘Sharpen the Instinct to Innovate: Using Innovation as a Tool to Manage and Thrive in a Downturn’ at the PricewaterhouseCoopers Managing in a Downturn webpage at pwc.com/ca/managinginadownturn.
Voice Over: In the next episode of Strategy Talks, Managing Risk: What Directors Need to Know, Helen is joined by three guests, Mike Harris (Leader of the Corporate Governance Practice at PwC), Brenda Eprile (the Risk Practice Leader of the GTA and National Internal Audit Practice Leader at PwC), and John Clappison (a former PwC GTA Managing Partner and current Director of a number of Boards). Here’s a sneak preview of what they had to say.
Mike: I think it really comes down to if you don’t have a lot of robustness to your risk management processes, if you haven’t articulated this risk appetite, if you don’t have a vision to what you’re doing around risk management you have no choice but to just go with your gut. And today I think most peoples’ guts are on the risk aversion side of the equation when you read the paper everyday that’s all you think about is what thing am I not thinking about and I better avoid it.
Brenda: Risk Management really isn’t a proprietary secret. It’s something that you know often you can share with even your competitors, so reaching outside your organization can be quite helpful in terms of what others are doing.
John: And as the prices hit, everything moved from quality of earnings, ROEs, all of these numbers to ‘how do we know we have enough money to pay our bills’, and so liquidity played a major risk factor that we’re settling on the table.
Dean: This concludes this episode of Strategy Talks, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I’m Dean Mullett, thank you for listening.
Helen: And I’m Helen Mallovy Hicks. We hope you’ll join us again soon for another episode. To download or to subscribe to this podcast series or to find more information on this topic, please visit our Managing in a Downturn website at pwc.com/ca/managinginadownturn.
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