Financial institutions and educators have propagated a way of thinking that is poison for innovation, Christensen said. And that thinking is around internal rate of return or IRR. As a result, investors are looking to put money to work fast and take it out as quickly as possible. This behavior is not only prevalent inside companies but also inside the venture business, he said. Christensen said that typically it takes about seven years or so to get a company to the finish line and get a good return on investment. Now compare that with an incremental product (or improvement) that you can flip quickly – that gives a big boost to the IRR.
As a result, venture capitalists are focused on short-term innovations and that is just nuts, he added. “I keep saying, don’t be distracted by the siren song of synthetic message of IRR,” he said. “It is dollars and not IRR percentage that matters.”
He thought the government should consider a new kind of tax structure that encourages longterm investments and stability. For instance, no capital gains taxes for investments that last as long as eight years. “Then you will find people like Steve Jobs and the vibrancy of innovation will return.”
Don’t think IRR thinking will go away but the same thinking can have opposite effects: some will take advantage of it to boost innovations that scale up quickly.