Innovation

Ralph Norris FAICD makes a telling observation on why some boards struggle to govern innovation and why industry is littered with large companies crushed by disruption.

“It’s hard to make an elephant dance,” says Sir Ralph, referring to the challenge of getting big organisations to engage in radical innovation, “creatively destruct” parts of the business, and be prepared to take risks and go backwards, so that they move forward.

“Large organisations are usually wedded to legacy systems, processes and people,” says Norris. “Their boards are generally risk averse and do not want huge asset write-downs from company transformations. Management is incentivised to beat last year’s profit and does not want to make transformational changes. The share market wants next year’s profit and shareholders want a steady dividend stream. That acts as an impediment to innovation.”

Norris’ view is timely. Technology-driven disruption is spreading like wildfire across industry, destroying incumbent companies and fuelling insurgent competitors. Canadian governance expert Professor David Beatty has described this as a “digital tsunami”, arguing that the majority of boards worldwide are unprepared for the potential damage. In Australia, just over half of directors said innovation had never been, or was only occasionally, a board item, according to a recent survey by the University of Sydney Business School, in partnership with AICD. And 57 per cent of director respondents did not know how much their organisation spent on R&D and innovation.

The study found: “While Australian directors accept the importance of innovation to their organisation’s strategy, too often competing priorities, limited resources, and a lack of awareness of the need for change mean the topic does not receive the urgent attention it deserves.”

Norris says some boards focus on the wrong innovation signals. “They talk about the organisation having a culture that supports incremental innovation, but that’s really just business as usual because companies should always strive to become more efficient. Or, boards look at the company’s R&D spend relative to competitors, or the number of patents filed. Plenty of firms that had lots of patents and looked innovative have failed over the years.”

“Boards should ask: If management was starting the organisation from a blank sheet of paper, what would it look like?”

Boards of large listed companies, says Norris, should focus on transformative innovations: the type that can combat disruption from emerging competitors and take the organisation in new directions, creating a step-change in growth and shareholder returns.

“Boards should ask: If management was starting the organisation from a blank sheet of paper, what would it look like? If it’s very different from today, they need to work with management on how the organisation can transition to a new structure, while minimising damage to legacy operations and profits. That’s hard to do because company transformations often create a level of risk that boards find unacceptable, so the status quo remains. Boards often don’t like the idea of a profitable low-growth business being destroyed, so capital can be reallocated to higher-growth, higher-risk opportunities.”

New Zealand-born Norris is well versed in company transformations. During a distinguished executive career, he developed a reputation for turning around underperforming organisations.

He turned ASB Bank in New Zealand from a second-tier bank into one of that country’s four major banks through deploying innovative technology and a focus on customer service that saw ASB grow at double the market rate every year during his 10-year tenure.

Then, Air New Zealand, which Norris salvaged from near financial ruin, and then the Commonwealth Bank, which was known for customer-service problems when Norris became its CEO in 2005. In conjunction with the CBA board, Norris oversaw a billion-dollar project to replace and upgrade the bank’s core technology systems – an innovation that would give CBA an advantage over its rivals and contribute to its outperformance during his tenure as CEO (until November 2011).

Norris believes the starting point for boards on innovation governance is understanding how their company is responding to the digital environment, its current and future competitors, and if its products are appropriate today and in the future.

The next step is people, says Norris. “Does the board have the right skills to support a higher rate of innovation and a company transformation? Is the executive team capable of understanding what the industry will look like in the future? Is it capable of creating and implementing change and bringing the entire organisation along on the transformation?”

Governing the migration of the legacy business to a more innovative structure is a key board challenge, says Norris. “It’s one thing to have a strategy for change. The harder part for boards is ensuring risks are well defined and capital is allocated appropriately; that the strategy is being implemented; and that the market is brought along on the transformation.”

Boards, says Norris, must be prepared for the organisation to be marked down by investors during its transformation. “Investors discount the company’s value because risks are higher. Boards need to look through short-term problems and focus on the future shape of the organisation and how it will get there. If they don’t do this, or become too focused on minimising risk, the organisation could pay a heavy price from disruption and lack of innovation.”

Increasing board focus on innovation

Roger Sexton AM FAICD says the biggest impediment to innovation governance is boards being swamped by recurring compliance tasks and other duties. “Boards need to separate innovation discussions from their regular duties and free up time to focus on strategy, innovations, competition and what the future of their industry looks like.” Dr Sexton’s view was reinforced in the University of Sydney/AICD innovation study. It recommended that “having regular conversations on innovation via periodic board agenda items can help make innovation a more mainstream boardroom topic”.

“We decided to separate discussions about innovation from the main board agenda, so we had more time for them and could hear from management and industry experts.”

Sexton chairs emerging listed food innovator Beston Global Food Company and is president of the AICD South Australia/Northern Territory division. He is the former chairman of financial services group IOOF Holdings, having retired from the board in 2016.

At IOOF, Sexton arranged a separate meeting the day before the main board meeting for directors and management to discuss organisation strategy, innovation and industry trends. Growth in financial technology (fintech) firms and their disruption potential was high on the agenda.

Sexton says the meetings were a key part of the board’s innovation governance. “We decided to separate discussions about innovation from the main board agenda, so we had more time for them and could hear from management and industry experts. Deeper discussions on innovation can easily get lost when the main board meeting’s agenda is packed.”

The innovation discussions before the main board meeting, some of which extended into dinner with directors and management, helped inform IOOF’s strategy and acquisitions, says Sexton. “I found the separate session a great way to focus on future trends and innovations. The discussions challenged the board and management on organisation strategy and driving growth in our industry.”

At Beston, a smaller company that listed on ASX in 2015, the focus is on constant innovation. The Beston board has a strong back-ground in start-ups, private equity and high-growth businesses.

“The board has regular discussions with management about latest global technologies that can be deployed in the business to make it more efficient, or product or customer innovations,” says Sexton. “In some ways, the board’s role is to ensure the organisation is always kept out of its comfort zone, and that pursuing constant innovation and improvement is embedded in its culture.”

Culture and innovation

Dr Nora Scheinkestel FAICD says boards must be willing to “disrupt themselves” when governing innovation. Scheinkestel, one of Australia’s most experienced company directors, chairs Atlas Arteria International and is a non-executive director of Telstra Corporation, AusNet Services and OceanaGold Corp.

“…people can get hung up on defining innovation as requiring a breakthrough or life-changing discovery. But innovation should be part of an organisation’s DNA and can be incremental.”

“Directors must be alert to trends in their market,” she says. “Boards worry about giving up too early on high-margin legacy businesses but if the organisation is a day too late in responding to disruption you can find vast chunks of your business disappear overnight.”

She adds: “Boards must be aware of the latest thinking, the changes in their industry’s ecosystem, from the nature and behaviours of customers to the changing identity of competitors, suppliers, distributors, the use of new technologies and so on. You need to be following what’s happening in your industry and in other sectors.”

Determining the organisation’s risk appetite is a key element of innovation governance, says Scheinkestel. “There may be some areas of the operation where there is little tolerance for risk but others where more risk can appropriately be taken. Sometimes, the board has a higher risk appetite than management. Being clear on the risk appetite helps determine the type of innovation the organisation will pursue, how much capital is allocated to them and their alignment with strategy.”

Innovation can mean different things to different people, says Scheinkestel. “In my experience, people can get hung up on defining innovation as requiring a breakthrough or life-changing discovery. But innovation should be part of an organisation’s DNA and can be incremental. It should be deeply embedded within organisational culture.

She says every employee should feel a positive obligation to innovate and that their organisation empowers them to do so, and rewards them for innovation success and for failure, provided there are learnings from it. “The culture must encourage staff to look for ways to do things smarter and better, to proactively address customer pain points. If it’s part of the culture, innovation just becomes part of how you do business.”

Scheinkestel says a culture of incremental innovation across the organisation can underpin more material breakthroughs. “If day-to-day innovation is not part of the mindset, it will be that much harder to undertake the innovations that can transform companies. The board needs to support a culture which actively strives to find smarter and more efficient ways to run the core operation, to take innovation risks. The reality is that many innovations fail and boards must be prepared for that and encourage the learning that comes from it.”

Boards should look at innovation as an element of organisational culture, says Scheinkestel. “Directors can gain insights on how staff view innovation through culture surveys, asking management to present on innovations at the firm or their analysis of customer data and how management responds to identified needs or pain points; how complaints are resolved. Listening to feedback from suppliers and distributors can also throw light on how the organisation is using innovation. It’s about boards finding ways to understand the views of different stakeholders on how management is addressing the organisation’s challenges.”

Executive team and innovation

Peter Hay FAICD, Chair of Newcrest Mining and Melbourne Airport Corporation, and former Chair of Vicinity Centres, says a board’s main contribution to innovation governance is choosing a CEO who can lead change in the industry and the organisation.

“The board must ensure the CEO is a change agent who is comfortable with uncertainty and deeply understands where their industry is headed.”

“The board must ensure the CEO is a change agent who is comfortable with uncertainty and deeply understands where their industry is headed. And that the CEO is capable of building and developing a team around him or her who can drive innovation – and an organisation culture that encourages higher rates of innovation, both defensive in terms of incremental gains, and offensive in terms of larger breakthroughs.”

The organisation’s innovation efforts must be supported by appropriate R&D investment, says Hay. “I would be disappointed if organisations I chaired lagged on R&D spending. I’ve seen how great innovations, such as block-caving technology at Newcrest, create value. Directors need to form a view on the R&D spend in their company, how that compares to rivals globally, and how that investment is being allocated. They should be aware of key innovations underway and keep track of their progress through regular management presentations to the board.”

Hay says boards should encourage management to keep up with latest innovations in their global sector. Vicinity directors and executives, for example, attended a study tour of major shopping centres, and met with industry experts and innovation thought leaders, in developed and developing countries and reported their findings to the board. “It really got the board thinking about the future of shopping centres, and how data and technology will create new opportunities and threats in the sector.”

Directors must find more time to talk about innovation among themselves and with management, says Hay. “I have always been of the view that board meetings should be about the future. The board should promote conversations about innovation as part of the organisation’s growth agenda and be clear on what type of innovation is sought.”

Ultimately, boards must regularly test management on whether the organisation can be more innovative. “Boards should resolutely refuse to accept that the status quo is good enough. There are always opportunities to improve a business through innovation if you look hard enough. If the CEO is not aligned with that thinking, the board has the wrong CEO.”