For more than a decade, unprecedented amounts of cheap money have encouraged companies to outsource innovation through M&A. Too many CEOs have fallen into the comfort zone of strategizing with bankers and external advisors, scheming about which company to buy — and neglecting to build their internal capacity for innovation.  

In particular, leadership loses interest in internal innovation when interest rates are low because cheap money creates the illusion that acquisitions are easy. When funding is plentiful, executives can readily execute and justify deals, so they pour all their energy into buying companies instead of empowering internal R&D. But the more a company ignores internal innovation, the more aggressively it must acquire. As it buys more and more outside firms to boost its own innovative capacity, it simultaneously struggles to retain key R&D talent because its internal culture is no longer sufficiently supportive of innovation. I call this the financial control trap because it cedes innovation to financial deal-making. 

Even in flush times, this cycle eventually risks the company’s failure altogether, as time and money get spent without sustainably generating any new innovations.Now, as the era of low interest rates and cheap money ends, many companies urgently need a new approach to strategic governance. To escape the trap, companies must replace the top-down approach of M&A with a more inclusive and bottom-up approach to innovation. While M&A seems like a cheap way to become more innovative, the most important information for innovation comes from inside the firm — from those close to customers, clients, suppliers, and technologies. For that reason, effective innovation strategy is inclusive and bottom-up. The financial control trap ignores that truth; and by seeking innovation outside the firm, it weakens internal capabilities.   

Let’s see the financial control trap in action, in a company that I worked with.   

After the financial crisis of 2008, when interest rates were near zero, a family-owned European media company acquired a series of firms to recharge its profitability and growth prospects. A CEO tasked with transformation invested in digital platforms to make up for declining print media.  

The strategy was sound, yet the acquisitions effectively marginalized in-house R&D investment as M&A drew management attention and funding away from internal work. The company did build significant R&D operations in Central Europe, but M&A drove a top-down ethos, inadvertently discouraging innovation from within. In the face of the inevitable culture clashes between old and new, the increasingly financially-minded company failed to integrate the acquired units with the rest of the organization — which kept it from achieving the expected synergies across the portfolio. Organic profit growth did not materialize. 

The result was an undifferentiated holding company, rather than the roughly coherent enterprise it was before 2008. All those investments did little to transform the core operations. The “comfort zone” of financial control crowded out the hard path of internal innovation.  

The company’s leaders and owners eventually recognized these challenges and began de-emphasizing financial control. But their efforts were too little and too late. Eventually, the company needed a significant capital injection from an outside firm that diminished the family’s authority.   

There’s one question I frequently get when explaining the financial control trap: Why can’t the board prevent the company from falling into it? Too often, well-meaning “best practices,” such as ensuring board independence, have estranged the directors from strategy and innovation processes and inadvertently privileged financial control. Board members are not encouraged to go deep into the company’s operations but are instead valued for their networks and introductions they can make to outside firms, including for prospective acquisitions. The board also depends on the CEO’s framing of the innovation imperative since it lacks the inside knowledge and bottom-up connections to challenge and guide a trapped executive leadership. As a result, boards usually end up facilitating acquisitions rather than pushing executives to build internal innovation.   

If there’s a silver line in higher interest rates, it’s that M&A will look less alluring. Companies still need to work to avoid the financial control trap, and that requires executives to recognize the importance of internal innovation driven from the bottom up.  

To do this, ask yourself: how often am I looking for innovation outside my organization’s walls? And how often do I ask my team what they’re seeing and what they think we should try? The more you do the former relative to the latter, the more at risk you are. It’s tempting to go hunting for that next big acquisition that will transform your company. But that can often be a mistake. The ideas and insights you need are the ones from people who know your company from within and know your customers.