The Board’s New Innovation Imperative
by Linda A. Hill and George Davis
THE CHALLENGE OF LEADING INNOVATION is bringing about a sea change in corporate governance. Boards, once the dependably cautious voices urging management to mitigate risk, are increasingly calling for breakthrough innovation in the scramble for competitive advantage. We see this shift playing out across industries—notably at such companies as Ford, Coca-Cola, Nestlé, and Unilever, which are all struggling to address slowing sales in their core businesses.
Embracing innovation and its inherent risks requires that boards and senior management develop new ways of working together. As Mark Ganz, the CEO of Cambia Health Solutions—a company at the forefront of innovation in the health care space—told us, board meetings no longer consist of PowerPoint presentations by management followed by a few perfunctory questions from the board. “The model has changed,” he explained. “We now bring the board ideas that are not fully baked and say, ‘Help us with this.’ ” It took some time for the board to realize that management was asking not for the answer but for engagement, he said, but “once they got used to it, it dramatically improved the board-management partnership and the value board members bring to the work of the company.”
The desire to create new and different ways of working is not always accompanied by the ability to do so, however. Adopting new roles and norms feels uncomfortable—even unnatural—to most people. To help address this knowing-doing gap, we spoke with directors and CEOs from a range of industries about their boards’ capacity to support innovation and risk management. The results were sobering, though the tide seems to be turning. A few of the directors in our study were clearly laggards, even going so far as to argue that innovation was irrelevant in their very mature industries. A handful were trailblazers, like Mark Ganz. The majority were just beginning to work their way through the challenges of governing innovation, some more deliberately and successfully than others.
Through our research, we identified the common obstacles most boards face and gleaned insight into how boards can reshape their roles to effectively foster and support the kind of innovation that leads to substantial growth.
Why Boards Struggle with Innovation
Boards increasingly believe that to fulfill their obligation to ensure the long-term well-being of their companies, they have to support management in developing a compelling innovation strategy. And that means learning to embrace risk while continuing to mitigate and manage it as much as possible. In this inverted risk paradigm, boards are discovering that avoiding risk is the riskiest proposition of all. Paula Price, a director at Accenture, Dollar General, and Western Digital Corporation, told us that boards should aim to develop the organization’s “capacity to pivot” into uncharted territory with new products, services, business models, or ways of organizing or getting work done. Standing still or waiting to see how things turn out are not considered serious options in today’s often tumultuous environment. A member of one automobile company’s board confessed that they had discouraged management from making the leap to electric cars for years; now he feared that the company was playing catch-up.
CEOs and top management appropriately have more power than board members over corporate affairs and major decisions. But without the full support of the board, management is unlikely to take the big bets required to innovate. What frustrations do board members report when asked about fulfilling their growing obligation to govern innovation? We found four main concerns:
An outdated innovation and risk agenda
Most board members report that the lion’s share of their attention around innovation goes toward improving the organization’s capacity to execute its current strategy—that is, innovation to sustain the core: developing product line extensions, reducing cost structures to maintain healthy operating margins, improving customer-intimacy and -centricity to address rising customer expectations, and responding to new regulatory regimes and cybersecurity threats.
At the same time, these board members realize that doing the same things better, faster, and more cheaply is not enough. It is not enough, for instance, to make improvements that reduce costs in the supply chain. Companies are now trying to deploy digital supply chains that will allow them to offer different value propositions to customers and even create new business models. As one director put it, “Significant disruption is taking place, and whatever company is at the top today will not be at the top in 10 years. [We] must differentiate ourselves." Another observed that his board’s “bias for short-term results” was stifling innovation; instead of pursuing breakthrough initiatives, the company was focused on evolutionary ones. Many directors acknowledged that it was not easy for CEOs to make the bold moves required to keep their companies competitive—especially given the growing demands of activist investors—and that boards were not doing enough to encourage management to pursue admittedly riskier initiatives that could reinvent the business.
Insufficient time
Making time for innovation as an ongoing topic of boardroom conversation is a luxury few board members feel they have. Especially in industries undergoing regulatory changes, such as financial services, energy, and health care, directors reported feeling “overwhelmed” simply attending to the basics of compliance and financial monitoring. Even companies that were performing well struggled to dedicate time to innovation activities. Hasbro CEO Brian Goldner acknowledged the challenge: “It’s easy to focus only on the core business when it’s going great, but you have to find board time to focus on growth and disruptive activities.” Directors we spoke with understood the need to invest in strategic discussion and debate about innovation—as another CEO put it, “To think you can sit in the boardroom and talk strategy once a year means you’re out of the game and out to lunch”—yet competing pressures on their attention made it hard to find the time for proper consideration.
Lack of expertise
Many directors—particularly CEOs—express frustration that their boards lack the level of industry expertise and innovation experience necessary to make well-informed risk-reward assessments about proposals. One CEO we spoke with said he actually avoided innovation discussions with the board because he believed that the directors “were too far from the market” to assess the true expected value of a particular innovation project.
Unproductive interactions between the board and management
Historically, companies have maintained a bright line between the board of directors and senior management. Under this governance model, management’s role evolved into “telling and selling” strategy and the board’s role became to ratify the senior team’s vision. Many of the directors we spoke with consider these practices to be outdated; however, navigating new roles for the board and management in setting innovation strategy is proving to be the toughest challenge of all.
Many board members reported a reluctance to ask their most-pressing questions, because they don’t want to be perceived as “micromanaging” or “second-guessing management” or as criticizing the CEO in front of his or her team. Meanwhile, several CEOs told us that their boards’ arm’s-length behavior inhibited the understanding and support required to forge ahead and innovate. When boards do dig into the details of management’s innovation proposals, their tough questioning can sometimes be perceived as hostile. Several CEOs experienced such interactions as evaluative of their own performance rather than of the quality of the ideas under discussion, and many complained that the board’s responses can be “harsh” or “unfair.” In some of our interviews, we could see the emotional toll of these often-heated interactions on the faces of board members and CEOs.
(Re)building the Board for Innovation
The research is clear: Innovation requires passionate discussion, debate, and even conflict—most often among individuals with diverse perspectives. To find better ways of governing innovation, more boards are revisiting both their board composition and the way in which they interact. However, directors are often reluctant to speak publicly—including to us—about how their boards operate, making it hard for boards to share best practices. This is especially problematic when it comes to innovation—an area where directors often feel there is work to be done. Our research revealed four key areas for improvement:
Diversity and collective literacy
When adding or replacing members, boards should take a disciplined approach, seeking members whose expertise complements that of the existing board and, more important, that of management. For example, a director of a traditional operations-focused company reported seeking board members with experience leading exceptional customer-service-oriented companies. Tom Wilson, the CEO of Allstate, pointed out that it was a board member from the manufacturing sector working with OEMs and some of the hot start-ups in the connected car space who was able to offer unique insights into consumer behavior.
In addition, most board members we spoke with wanted more people with technology experience—so-called “digital directors.” They believed that directors from organizations reputed to be tech pioneers were likely to be more familiar with the challenges that come with doing innovative work and better prepared to offer informed advice on how to address them. They also wanted directors with the capacity to assess whether or not their companies were investing sufficiently in technology and associated talent.
To further bolster out-of-the-box thinking, a few boards are explicitly including intellectual or problem solving diversity-difficult qualities to assess—in their composition matrices. Most directors we spoke with expressed concerns about whether their board composition was representative of their customers and stakeholders (with regard to factors such as gender, nationality, race, and ethnicity). And a handful of boards are making serious efforts to bring in younger-than-usual candidates, including Millennials, betting on potential rather than experience—a dramatic shift from the traditional approach.
For diverse individuals to collaborate effectively, they need shared experiences and knowledge to serve as a foundation for their interactions and decision making. Forward-thinking companies actively develop the collective literacy and contextual intelligence of the board—cultivating, in particular, a shared set of assumptions about where their industry and markets are going so that they are prepared to make the right risk/reward judgment calls together with management. Nearly half of the directors we spoke with bring in experts from different or adjacent industries to hold “master classes" Some hold sessions with angel investors and venture capitalists to gain their industry insight. Others make visits to technology hubs such as Silicon Valley, accelerators in emerging markets, and companies and academic laboratories working on the cutting edge of a given area. A few told us they meet with key customers in small groups, while others say that their entire boards attend industry conferences together. Directors reported that all these activities prompt important discussions about their appetite for innovation by exposing them to “next practices,” not just best practices.
Creative abrasion
This is the ability to develop a marketplace of ideas not from a single flash of insight but from a series of sparks generated through rigorous discourse and debate. Boards today recognize that creative abrasion is a core capability needed to engage in innovative problem-solving. One board member remarked, “Critical thinking is imperative, and that involves putting some friction into [the discussion] to fight the status quo.” Another stated, “Sometimes you need to create tension to stimulate thinking, ideas, and innovation.”
Indeed, the “mostly silent” board member is no longer seen as doing the job. The outspoken director once perceived as a “gadfly” is now accepted, even welcomed, in the boardroom. Boards need to learn to “tolerate some chaos” in meetings, according to one board member, if they expect management to engage in creative thinking. They must build a culture in which contrarian viewpoints are heard, even actively seeking directors with the “willingness and the dynamism to really mix it up in the boardroom,” as one CEO told us.
We weren’t surprised to hear that many boards are reluctant to have the frank conversations required for innovation because the dynamics of creative abrasion are so tough to manage. The default for many board members is to avoid conflict and become “too polite.” Facilitating creative abrasion is a delicate dance: Boards that are too supportive fail to sufficiently challenge proposals, but too much confrontation can stifle people’s willingness to offer ideas.
Redefining the partnership
Balancing the board’s legal power and management’s executive power is not easy, but for innovation discussions to happen, neither side can dominate. Boards need to build a strong partnership with management and a sense of shared ownership of the innovation strategy. Allstate CEO Tom Wilson told us that unlike most boards, which meet to discuss strategy once a year, his board holds two separate strategy meetings: One is a dialogue about the company’s capabilities and market position and is focused on learning; the other is for decision making.
Some CEOs are getting more comfortable using the board as a thought partner. One described his board meetings now as “great idea-sparring sessions,” with a healthy degree of conflict and debate. As one of his board members admitted, she had to learn “how to have her nose in, but her fingers out.” Understandably, these sessions can be emotionally draining; some CEOs said they felt that their boards sometimes overstepped or “came on too strong.” The CEO of a Fortune 100 retailer told us, “I’ve learned from watching other CEOs and boards that if a board gets too far in the weeds, it is deadly.” Boards can avoid these issues by clarifying expectations at the outset.
Our research indicates that management teams are increasingly willing to make themselves vulnerable, embracing the board’s probing questions about their big-bet ideas and even discussing efforts that didn’t pan out. The more courageous CEOs we spoke with said they now seek more input from their board rather than less. One said he encourages dialogue with the board by asking management to share not only recommendations but also the other alternatives that were considered and rejected. Without this transparency, he explained, board members get frustrated and feel as though they are being “sold stuff” by management.
Getting to a place where management teams feel they can bring forward a portfolio of ideas, some of which are more developed than others, requires a real partnership mindset with boards—a shift in the conventional relationship between the two bodies. As former CEO of Mastercard Bob Selander told us, “Some people like to think that one big idea will lead to massive change, yet great boards recognize that it takes ongoing discussions about lots of ideas—the good and the bad—to produce breakthrough results.” For one CEO, this meant coaching his executives to expect and be open to hard questions and criticism, acknowledging that it’s not easy for his team to expose themselves (and their proposals) to negative reactions from individuals who often have less expertise about the matters at hand. “We had to be very explicit about saying, ‘We are not asking for your approval; we are still trying to figure this out,’” another CEO told us. Another said that trust was essential in building a collaborative mindset. “There’s a sense now that when we get done with a conversation, neither side feels beat up. Instead we feel like we got to a better decision.”
Encouraging risk and living with failure
Boards know their companies must pursue not only incremental improvements but also breakthrough innovation. To foster both kinds of activity, they have to create a culture that is receptive to risk and the inevitable failure that comes with innovative problem solving. However, boards are not—and should not be—interested in innovating for innovation’s sake. To avoid innovation activity that doesn’t “move the needle,” CEOs and board members we spoke with focused on taking risks on efforts that were most likely to create shareholder value in the long term.
Determining whether an innovation at scale will be worth the investment is a very difficult proposition. One board member told us, “Discounted cash flow analyses won’t help us make a discussion about a breakthrough idea.” This is especially the case in large companies where, as one CEO observed, it is always difficult to make a significant impact on topline growth.
Most board members in our study admit that they struggle with how to weigh shorter-term financial outcomes against other measures—such as customer-experience or market-share metrics, which might be better indicators of whether an innovation will bear fruit and improve the company’s competitive position in the long run. Rather than rely on outcome metrics, some boards are beginning to depend more on process measures when evaluating innovation initiatives. For example, one board member said that he frequently asked his team what the company was learning about its customers as it experimented. In some cases, boards also track vitality indices—the percentage of total revenue that comes from new products and services—to measure the organization’s innovation capacity as a whole.
We know from a deep body of research that many—even most—innovation efforts fail. So boards must learn to recognize when an initiative should be abandoned. A number of board members said they wanted their companies to figure out how to “fail fast and learn fast” so that they can get on with other endeavors. Some directors said they now make sure to state aloud in board meetings that some innovation efforts should be expected to fail. Although none of the board members we interviewed reported having discussions about the difference between “praiseworthy” and “blameworthy” failures, as Harvard Business School professor Amy Edmondson calls them, they recognize that you can’t plan your way to an innovation, you have to act your way there, and that there are bound to be missteps along the way. Indeed, board members say they are wary of CEOs who “play it safe,” as one described. A sizable number of the search committee chairs we spoke with said they are skeptical of executive candidates who have never experienced failure and look for potential CEO successors to show, as another director said, “stretch efforts that included missteps and learning from them.”
Governing innovation is not for the faint of heart. The journey takes time and determination. It takes the courage to act in the long-term interests of the organization even when markets are more shortsighted. It takes the determination to fight the natural human aversion to risk and the fortitude to engage in creative abrasion.
Balancing power between the board and management has never been easy, but our study suggests that as more boards are embracing new norms, a new contract between boards and management is emerging, making it possible, at last, for directors and CEOs to work together to support and facilitate innovation.
Originally published in November–December 2017. Reprint R1706G
What Amazon’s Board Was Getting Wrong About Diversity and Hiring
by Stephanie K. Johnson
Amazon came under fire after its board opposed a shareholder proposal to increase the diversity of the board in May of 2018. (The company responded to blowback by reversing the decision just one week later.) CtW Investment Group, an activist shareholder group, requested that Amazon implement something much like the “Rooney Rule,” a requirement instituted by the NFL in 2003 that every team must interview at least one minority candidate for an open head coach or general manager position. In Amazon’s case, the proposal required that “the initial list of candidates from which new management-supported director nominees are chosen should include (but need not be limited to) qualified women and minority candidates.” At the time, all 10 of the directors on Amazon’s board were white, and seven were men.
Companies like Microsoft and Costco use this type of process for their board selection, as increasing diversity of candidate slates is an important step for increasing diversity of the board overall. But Amazon’s board recommended voting against the proposal. In its SEC proxy statement to shareholders, the company stated that it already had “complex processes” in place to select board members and that this new requirement would not be a good use of its time or resources. Amazon’s communications representative suggested that using a policy like the Rooney Rule was likely to create a “check the box” approach, which is something I’ve found in previous research.
However, two points are worth mentioning. First, this suggestion misinterprets my findings with coauthors David Hekman and Elsa Chan in HBR. Our research, which explored status quo bias, or the desire to preserve the current state of things, found that when there is only one woman or person of color in a finalist pool of job candidates, that candidate stands out so much that they have essentially no chance of being hired. This is consistent with the idea that simply interviewing one African American applicant—as required by the Rooney Rule—would not create change. But importantly, we also found that interviewing two women or minority candidates can make the difference and lead to their hiring. So the evidence suggests that mandating diverse candidate slates can improve diversity overall.
This finding holds when we look at the Rooney Rule itself. My colleagues and I researched who was interviewed for the 35 head coaching positions the NFL saw open over the last five years (2013–2017). Of the coaches who have been hired over this period, 29 have been white men and six have been black men.
Most of the time (in 22 instances), only one black coach was interviewed, but in 12 cases two or more black coaches were interviewed. From the 22 times that only one black coach was interviewed, a black coach was only hired once, which is about 5% of the cases. (On average, about five potential coaches are interviewed for each position. So by chance alone, you’d expect a black coach to be hired 20% of the time.) But from the 12 instances where two black coaches were interviewed, a black coach was hired four times (or 33% of the time), which is closer to what you’d expect if each candidate had an equal chance of being selected. These are small numbers; however, the difference between them is statistically significant (B = 2.35, p < .05, EXP(B)=10.50).
There is little doubt that the Rooney Rule brought change to the NFL: It changed the culture and increased awareness about the lack of ethnic diversity at the top of the league. But concerns that progress has been too slow (considering that 70% of players but only 25% of head coaches are African American), can be explained by the fact that interviewing one African American head coach is simply not enough. Our data would argue that if teams were required to interview two African American coaches, that number might increase to 33%.
So when it comes to companies like Amazon that are afraid of “creating token candidates”—individuals who are interviewed to “check a box” but given no real consideration—on finalist slates for board positions, I agree: Interviewing one person of color might not necessarily lead to greater diversity. But the crucial point is that interviewing more than one might—and interviewing all white candidates will obviously not result in hiring a person of color.
The second point worth mentioning is that Amazon’s resistance to a formal requirement about diversity isn’t unusual. In my work interviewing CEOs of S&P 500 companies (conducted with Kim Davis), I learned that companies are often reluctant to change their board practices due to fear of change and the unknown. It feels much safer to share your greatest corporate secrets with people you already know, which probably explains the strong and consistent data showing that most new board members are recruited from the small, preexisting networks of current board members.
It’s been found that CEOs who increased the demographic diversity of their boards elicited higher profit margins for the company, but it came at the expense of lower pay for themselves. And using 12 years of data on Fortune 500 companies, other researchers showed that demographically diverse boards are more likely to challenge the authority of the CEO and curtail CEO pay. A McKinsey study showed that only 14% of C-suite executives select board members on the basis of having a “reputation for independent thinking.”
My research found that CEOs who did push for diversity on their boards were very focused on the benefits it would bring, while CEOs who did not tended to focus on the things they would lose (like the current group dynamic) or the risks they would encounter (like that people might think the candidate is a token hire). Psychologists have a theory differentiating between these two perspectives: They have found that a focus on playing to win (what’s called a promotion focus) can result in growth and improvement in business outcomes, but a focus on trying to avoid losing (prevention focus) tends to result in stagnation.
So focusing on the potential gains in having a more diverse board—such as diversity of thought, a more comprehensive understanding of the customer base, and reduced groupthink—would seem to encourage CEOs to be more intentional about increasing board diversity. Focusing on the risks, on the other hand, would result in maintaining the status quo—which usually means a board composed of all white members.
The truth is that the status quo is hard to overcome. Selecting a board is kind of like choosing the group of people you want to spend Thanksgiving dinner with—you want to like them and feel comfortable with them. But the magic happens when things are not quite comfortable, when you are hearing different perspectives and being challenged on how you think. Difference of thought and perspective is what makes companies great.
Compared with the other tech companies that have mostly white executives (68% at Apple, 65% at Google), Amazon is among the worst in terms of diversity, with 74% white executives. Of its 18 highest-level executives, 17 are white men. Clearly the company’s employees care about increasing diversity in the upper ranks, and Amazon stands to gain by being more representative of the people it serves. Appreciating the need for diversity, and setting some real goals for achieving it at the highest levels, is the only way to ensure that it exists throughout the organization.
Adapted from content originally published on May 14, 2018. Reprint H04BZ2