Financial analysts decided to measure success using ratios instead of whole numbers due to the development of a spreadsheet and the desire to compare the performance and profitability of companies from different industries. There was no way to contrast organizations that had different business models with whole numbers because they did not provide much information. However, financial analysts understood that they could compare the success of two different companies by using ratios. Fractions summarize different figures around the denominator.
Finance people understood that if the company wants to grow, they need to use several metrics to measure success, which are the return on net assets (RONA) and internal rate of return (IRR). Companies started analyzing the opportunities that they can extract by thinking in numerator and denominator terms of ratio. If a company wanted to become more profitable by being more innovative, finance people would put the profit on the numerator and the assets on the denominator. As it is stated by Professor Christensen, the company might find it hard to be more innovative. Thus, instead, it would decrease its assets by outsourcing them to improve the ratios. The pursue to outsource more to enhance RONA or IRR suggests that financial analysts are likely to promote efficiency innovations and short-term projects because they get payoffs faster and influence the main ratios. Professor Christensen claims that corporations and countries are losing growth now due to ratios finance theory was teaching analysts.
Analysts prefer efficiency innovations over disruptive innovations because when they assess the profitability of projects with ratios, they see that disruptive innovations will pay off in more than five years and will decrease the IRR. Instead, they suggest putting resources in efficiency innovations to create free cash flow. The cash flow increases, but the problems stay the same. Financial analysts insist on placing capital into efficiency innovations that lead to zero growth. Professor Christensen emphasizes that disruptive innovations led to the growth of countries’ economies because local companies continuously put resources into producing disruptive products that fueled the growth. However, nowadays, when analysts measure innovations in ratios, they observe flat or zero growth because companies are not organized to invest in growth, and they only get a temporary improvement that they cannot sustain.