We had some rain here over the weekend. Here is what was reported in yesterday’s Australian Financial Review (emphasis added):

Heavy rains fell across NSW and south-east Queensland over the weekend, which flooded homes and roads, brought down trees and caused motor accidents. But in good news for Sydney, 115 millimetres of rain fell across the Warragamba catchment which could result in dam levels rising over the coming days. The rainfall is ill-timed for the NSW government as it coincides with the switching-on of a $2 billion desalination plant, which will run regardless of dam levels for the next two years as it undergoes engineering testing. Nevertheless, dam levels remain at 50 per cent of capacity and this is the first significant rainfall over the Sydney catchment since mid-2007…

I am still astonished by the logic in the part that I highlighted. It is basically saying this: Australia has been in a country-wide drought for 7 of the past 8 years; Sydney hasn’t had any significant rain in 2.5 years; the dams have fallen below 50%; but the $2 billion investment in a desalination plant might look bad because it rained over the weekend. This is lunacy.

The desal plant may or may not be a good idea. Whether it is or not will depend on a number of factors – projected rainfall over the coming years, projected population trends for the Sydney region, and trends in water use/conservation. Many of the assumptions that underpin a model of the impact of a plant will be debatable. Nevertheless, there is simply no way to judge the wisdom of a $2 billion investment based on whether it rained this week or not. This is the worst kind of short-term thinking.

We see the same thing happen in business here. Every time there is a down-turn in the price of iron, multiple mining projects are put on hold. To me, this doesn’t make much more sense than judging the merits of a desal plant based on last week’s rainfall. According to some talks I’ve had with folks in mining, the thing that is happening here is that their due diligence systems require them to calculate the net present value of projects based on current prices. So when prices are high, they build like crazy, and when prices drop, everything stops. It seems to me we’d be better off looking at expected long term prices of whatever they’re digging. But then, the miners are all making a ton more money than me, so maybe I’m missing something…

This is also an innovation problem. When the global financial crisis hit at the end of 2008, investment in innovation fell through the floor through pretty much all of 2009. This is, again, crazy – for a couple of reasons. Tom Fishburne illustrates the first reason perfectly (his cartoons are great, and you should check out his site):

He’s drawn it exactly the way that I talk about it in classes – you can’t just turn innovation on and off like a faucet. Innovation takes time, and it needs a process. Short-term thinking combined with NPV hurdles for new ideas is one of the best possible way to ensure that you will never come up with an innovative idea again.

The second reason that it is crazy is that we know that the best way to manage innovation is through the use of some kind of portfolio process. This mixes small bets with big ones, and it is the best way to make sure that we have a constant flow of good new executed ideas. One tool that is very useful for this is the Three Horizons model.

We have talked about this a few times – the very short description is that the first horizon involves implementing innovations that improve your current operations, horizon two innovations are those that extend your current competencies into new, related markets, and horizon three innovations are the ones that will change the nature of your industry.

When we shut off innovation in a downturn, it is usually the longer-term innovation projects that get killed. These are the ones that will ensure that we are still in business in five years, or in ten. It is absolutely critical that we consistently innovate across all three time horizons. Unless our very survival is under threat right now, we can’t afford to stop investment in innovation. Even if it did rain over the weekend.

(Storm photo by flickr/Richard.Fisher under a Creative Commons license)