Who Solved the Capitalist’s Dilemma?

In The Capitalist’s Dilemma, Clayton Christensen and Derek van Bever introduce a powerful new theory which explains the relative paucity of growth in developed economies. They draw a causal relationship between the mis-application of capital in pursuit of innovation and the failure to grow.[1]

In particular, they observe that capital is allocated toward the type of innovations which increase efficiency or performance and not toward those which create markets (and hence long term growth and jobs.) This itself is caused by a prioritization and rewarding of performance ratios rather than cash flows and that itself is due  to a perversion of the purpose of the firm.[2]

For this statement of causality to be confirmed we need to observe whether it predicts measurable phenomena. For instance, we need to see whether companies which create markets apply capital toward market-creating innovations and whether companies which create value through efficiencies or performance improvements hoard abundant capital.

Over the entire global economy, the pattern of capital over-abundance is easy to see. The amount of cash or securities on balance sheets is extraordinary and unprecedented (estimated at $7 Trillion, doubling over a decade). However, growing cash is not a perfect indicator of inactivity. Cash is the by-product of earnings after investment. So if operating profits are growing and investment is growing, but not as fast, then it’s possible to grow cash while still growing investment.

The better measure is investment in capital equipment or, more specifically, purchases of plant, property and equipment.[3] Indeed, on a global scale, capital expenditure as a percent of sales is at a 22-year low.

CapEx is a good proxy for non-financial “investment”. It’s also a measure that can be easily obtained as companies report this activity in their Cash Flow Statements.

So the best method for assessing the theory’s predictive power is to look at market creators and measure their investment in PP&E. At the same time we need to look at market sustainers and measure their (probable) lack of investment in PP&E.

So here is my first attempt:

Screen Shot 2014-05-27 at 5-27-3.25.43 PM

It’s an admittedly small sample of companies that are not that dissimilar. But within this group, over the time frame of about 9 years, we can see how capital expenditures are growing.[4] This sample shows that for a few companies, the amount spent on capital equipment grew dramatically. Especially since they are in businesses that might be thought of as not capital intensive.

Consider Amazon: an Internet company if there ever was one. Their purchasing of capital equipment (in which they also classify software) went from 373 million in 2009 to $3.8 billion in last four quarters! The average spending was $84 million in the four quarters ending September 2009 and $964 million in the year ending March 2014. Amazon is investing in data centers and distribution centers and they are growing that asset base with an eye toward future growth.

In contrast, consider Intel. Intel is in the most capital-intensive corner of the technology industry: semiconductors. They still manufacture their own so their investment in “fabs” continues. But Intel failed to create a market for mobile devices. The number of ARM processors shipped in 2013 was about 10 billion units while the number of Intel processors shipped was around 400 million.

So despite being an innovator, Intel did not create a market. They still increased their CapEx but only by a factor of 2. Is this because Intel did not invest in market-creating innovations? Had they invested in market-creation, would they be increasing CapEx accordingly?

Now look at Samsung. Samsung has grown CapEx by a similar factor to Intel (from pre-recession $2.5B/quarter to average of $5.5 during the last three years). Did Samsung create markets? Much of the expenditure went toward supplying components to itself and Apple (and others). In that regard, they did not create the market but filled it and optimized it.

Then there’s Google. Google increased CapEx from an average of $476 million/quarter in 2006 to $2.125 billion in the last four quarters. That’s an increase of 347%. Google spends almost all CapEx on data centers and we can see a pattern where CapEx growth anticipates service growth. However, the growth is not as pronounced as Amazon’s.

Microsoft also grew CapEx. Their investment mirrors that of Google: data centers. Microsoft increased from an average of $508 million/quarter (very similar to Google) in 2006 to $1.5 billion today. That increase is about 200%, slower than Google but in the same trend. Did Microsoft create a market since 2006? In terms of cloud computing and software as a services, yes. Their spending growth reflects infrastructure that supports a new business model.

Finally there’s Apple. In this time frame Apple did create the iPhone and iPad and their growth went from less than $200 million/quarter in CapEx to over $2.5 billion/quarter. The increase is nearly 10x over 25 quarters.

To summarize, the following graph shows the increase in average quarterly spending (over a four quarter period) between 2006 and the present for these companies.

Screen Shot 2014-05-27 at 5-27-3.10.40 PM

The degree of “market creation” may be visible to the naked eye: Apple and Amazon did clearly create markets and they show highest CapEx growth while Intel and Samsung did not and they show the slowest CapEx growth. Google is continuing the expansion of a new market as is Microsoft and their CapEx growth is roughly proportional to these efforts.

At least from this small sample the theory seems to hold. CapEx and market creation are at least correlated.  Much more analysis needs to be done, especially to discover the anomalies, but from the perspective of some of the most valuable and rapidly growing large companies, their commitment to capital expenditures is evident.


  1. and, indirectly, in the increase in inequality and hence the destabilization of socio-political institutions []
  2. That being the creation of customers not shareholder returns []
  3. Operating expenditures can also be measured but they cannot grow inorganically due to most of the costs being related to skilled employment which has supply constraints. []
  4. Note that Apple’s data extends to the end of their fiscal year and reflects their forecast given last October in the 10-K filing []
  • stefnagel

    Nice. Plant, property, and equipment equal commitment. I wonder if that term might not be expanded to social commitments.

    As a long time worker in the nonprofit sector, I would add an authenticated mission statement that focused on change, ala Drucker; he understood the non profit sector as the most creative sector in the US, and unique to it.

    Here’s the link: New markets, in any sector, require social change.

    • Sacto_Joe

      Regarding Amazon, they could give a fig about social issues:

      I surmise that their ability to build out as quickly as they have has a lot to do with their utter disregard for humanity.

      • stefnagel

        Actually Amazon is a classic nonprofit enterprise, in which any surplus is expended on the cause and which is supported by contributors (wallystreet) who disregard profits as well. And millions vote with their wallets for Amazon’s aim to reduce retail to rubble. We get the change we vote for.

  • Emilio Orione

    Can long term growth be seeded, that’s the question.
    If it is related to CapEx, can CapEx be stimulated with tax legislation?
    It is only a matter of ideas and execution, of will, or a matter of cost of investments?
    Even if current stimulus are allocated to new companies, growth tend to come from existing companies which have more possibilities of investments and execution.
    Our politics have to change to stimulate growth and our perception on how to do it must change to.
    Even if cost of money is low reducing taxing on CapEx could enhance future growth and jobs creation more than public spending to help startups.

  • Sharon Sharalike

    $22B by Amazon?

  • Walt French

    Intel is such an interesting case. Since they turned down Apple’s request to supply a chip they were currently manufacturing (motivating Apple to go to Samsung), and sold the line to Marvel, Intel has clearly focused on dominating the X86 business, which has been very profitable, which the ARM business might never be. (Although why it was pre-ordained that Intel couldn’t have staked out a dominating ARM position in 2005 is much less clear.)

    Having volunteered to sit out the mobile revolution, Intel today finds itself in the place of not having to compete very hard with AMD, nor having much way to expand their current market. Even if they doubled R&D and CapEx, they’d still face a saturated market that they dominated; no more profits from spending more money but selling no more chips!

    I’ll take issue with just the notion that ratio optimization is “a perversion of the purpose of the firm.” Intel’s strategy maximized its short-term profits and possibly kept it from pouring shareholders’ money down a rathole of cutthroat competition for no return, with a design that Intel would never control. I think that’s generally true of short-term decisions: they’re designed to improve total profits, and the fact that long-term, the tactics take down both total customer value and the ratios indicates that it’s just a natural side-effect of poor ability to emphasize the long-term, which is all too frequently seen in capitalism.

    Dell is a fine example of a company that recently imploded by cravenly trying to extract too much ROA But Sun Micro was a sad example of a firm that boldly introduced powerful new hardware in the face of the bursting of the internet bubble, and quickly found itself unable to sell the dramatically better gear until the market recovered; meanwhile other, more short-term-aware firms such as Dell and HP, were able to exploit having kept their powder dry as Sun floundered, having over-committed its resources to the then-outdated servers. (Yes, HP has a sorry record in many regards, too.)

  • Ed Dietrich

    Another metric to add, to the degree it is discoverable, would be the number of FTE’s during those periods by each company

    • charly

      Not really Amazon has a lot of minimum wage jobs, Apple some and the others none.

      • Ed Dietrich

        Understood and acknowledged. For that reason, I’m a little dubious of PP&E as a proxy for growth

  • rational2

    Any discussion of rate of growth of cash and equivalent liquid assets in balance sheets should also mention the rate of growth of debt on corporate balance sheets.

    Debt has been growing faster than cash on the collective corporate balance sheet. In other words, they are just creating money in one moving that to another.

  • Walt French

    The 800# gorilla here is that these ratios replaced some earlier measures that Christensen previously (and quite aptly) criticized. The discussion above could imply to some, that total growth was the goal; a company that tied up lots of its capital in low-returning projects could look good on that basis, while guaranteeing that in 5 years, when the business was obsoleted and the capital had to be written down, that the company took a horrible loss on the low-value-add capital.

    Capital budgeting is a tough subject, all the more so in such dynamic industries as the companies here participate in.

    So the problem is well-stated: excessive emphasis on ratios keep managers from over-emphasizing projects with crummy returns, but they also might keep managers from taking good, long-term projects. How do we throw out the bathwater of the crummy projects without losing the baby of capitalism?

  • Terry

    Looking at CapEx growth can be a bit misleading. Horace states that a correlation between creating markets and CapEx growth is apparent. But creating new markets can come at the cost of destroying old markets. Hence, CapEx growth could be 0 if new markets are being created when similar sized old markets are being destroyed. If ‘creating new markets’ and ‘destroying old markets’ is just another day at work, then CapEx could be flat while avoiding the Innovator’s Dilemma. Looking at Microsoft proves my point, they did create new markets (Dediu points that out), but CapEx is relatively low. However, given the dominance and size of Microsoft in 2006 and earlier, a lower CapEx than Apple/Amazon is reasonable.

    Maybe a broader sample (more companies) and identifying CapEx as a percentage of revenue could give some more insight.

    • Naofumi

      I agree that you have to look at the aggregate of markers created and markets destroyed. This is about the whole economy and not about a single company.

      If you look at Amazon, it is obvious that for any jobs they created in there warehouses, they destroyed more in brick-and-mortar stores. As a sum, jobs were destroyed. Hence negative for the economy.