Gearshift

Manual gearshift of a car

If we analyze the relationship between complexity and innovation, we can see how the performance of innovation can be evaluated. Complexity is an energy that every organization has stored inside. Energy is the capability to provide a work, or in economic words production. Organizations have different assets that are the stores where this energy can be found. The machines at the production plants, the money at the bank, the knowledge of their engineers and salesmen are the internal energy of the company that be used to provide production. The energy stored at the company can be interchanged with the environment in form of work. External work can increase the internal energy of the company if we acquire new goods and services to be incorporated to production.

The structure of a company defines how the energy stored can be applied to provide production. If you have money in a deposit, it cannot be used to provide production, however if money is in a current account it can be used to provide production immediately. If money proceeds from a credit that must be returned immediately, it cannot be applied for a production that requires more time. In microeconomics this is well known. Long term assets should be financed with long term liabilities. A company is well structured when some part of the short term assets are financed with long term liabilities, this is known as the working capital. As we can see there is a clear relationship between the structure of the financial assets in a company at the balance sheet and the health of that company.

This can be extended to the full structure of the company. Not all the assets of the company are well reflexed at the balance sheet. An example is the experience of the workers. Classic strategy shows how some activities can take advantage of the experience of the workers when a new activity is introduced in a company. Although the initial cost of the activity can be very high, workers learn to increase the efficiency of their activity improving the benefit of the company. This experience is not reflexed as an asset at the balance sheet however its effects can be seen at the income statement. Looking only at the balance sheet, we would never affirm that fixed contract for workers are good for a company, however, if experience is a long term asset it should be equally preserved on the long term with long term liabilities.

We can see how structure can be a value for a company, increasing the efficiency of the processes and it can be considered the reason for a healthy state of the company. This should be true when things are working, following an engineering concept, in steady state, however, environment changes. When the environment changes, our company must change to fit the environmental changes, if the structure is large and we cannot change fast enough the business can run bad.

For instance, if you have contracted a long term credit in a currency and you want access to other market and it lets you to get additional incomes, you could not take advantage of that business opportunity if the exchange rate increases fast changing the credit in a currency for a credit in another one. In this case, financial structure is limiting your capability to run your business in good conditions in front of the competition.

The same thing can happen with assets out of the balance sheet. If competition has introduced a new technology in the market, the experience of the workers is not a competitive advantage yet. Fixed contracts would not be a sign of a healthy business but a competitive disadvantage and the reason of an ill business because we could not change the experts in the old technology for experts in the new one fast enough.

As we can see the healthy characteristic of the structure is time dependent. Structure improves the efficiency of the activity and the health of the business in steady state, however, it can be a heavy load far from it. Organizations usually preserve some kind of free behavior in order to be able to fit common little changes of the environment. A car without a gear box can run very fast, however, the gear box lets it to accelerate from 0 to the maximum speed much faster and helps you to win a race.

Innovation is an activity that provides changes in the structure of the company, for instance, if we are running a company with a single product, and we introduce a new one, we will need both different financial structures to accommodate the new productive capability and new knowledge and machinery in order to manufacture it. The former change will be able to be seen at the balance sheet, however, the latter one will not. The performance of the innovation will be linked to if the new structure will take advantage of the environment better or worse and if the new disposal will be able to fit environmental changes better or worse. This can be analyzed through a complexity analysis.

In this case, it is not only necessary to determine if a new product due to innovation will be able to increase the performance of the company, but if it will be convenient to abandon the old product in order that the company preserves a healthy behavior or not.

Advertisements