Nothing in business stands still. Enterprises that do not innovate will at some point struggle to survive as new offerings come into the market or conditions change. This means boards must be able to monitor whether their companies are innovating. While it is not the directors’ responsibility to do the innovating – that is the job of the company’s management and staff – they must be able to detect whether it is occurring.

For many boards this requires a change of thinking. Rather than undertaking their usual activities of monitoring for compliance, or for a required level of success, the approach is the opposite: monitoring for something new and for the right kind of failure.

“The biggest block to innovation is the fear of making mistakes,” says executive coach Charles Kovess MAICD.

“Very few Australian companies have a policy on how to handle mistakes, and unless there is a policy, mistakes will be punished. The only time innovation, creativity and learning occurs is when it is safe to make mistakes, to fail and to keep practising. Unfortunately in Australia we are unusually negative on that.”

Innovation has to be part of the culture, says Russell Yardley FAICD, chairman of cyber security services company Tesserent and former chairman of advertising agency George Patterson Y&R. He says boards need to work with management to measure results. “They need to be looking for where things have tried and failed,” he says. “The board’s responsibility is to set an appetite for innovation.”

Yardley says large organisations are very efficient at exploiting the assets they have developed. But they also need to explore and exploit new opportunities. “Companies need to think carefully about how they are placed in their stage of development, their cycle as an enterprise, and in their industry. Are they really about exploiting, or do they need to be exploring for the future?

“If you are doing none of one, and all of the other, you are probably not in good shape. The board needs to think about those things and identify what encouragement they need to give to their executive. Are they being too innovative? Or are they not exploiting to build the assets to give the company the capacity to innovate in the future?” says Yardley.

He cites urban studies theorist Richard Florida’s ideas about the creative class as a good guide. Florida argued cities that are creative have technology, talent and tolerance. Yardley believes the same is true for an enterprise. “If you really want to have an innovative and valuable, sustainable, enterprise, you need to measure whether you are using the right technology. What are our competitors using? Are we using it well? How do we measure the users of technology? Have we got the right talent?

“Smart people attract smart people. So boards should be looking at attrition rates. Not so much for their size and number, but to see who is leaving. Are bright, talented people leaving the organisation? Because if they are, then there is a lesson there. The board needs to make sure that the talent attracts other talent that wants to be in the company,” he says.

Tolerance is also important in company culture, argues Yardley. “If you don’t have tolerance you don’t end up with that culture of making mistakes. The board’s job is not to do the doing, but to do the governing and provide oversight. When you fail you don’t want to just move on. Really innovative companies focus on those failures to learn from them. Accountability is critical. Sometimes the board can see the executives are too buried in these things and it becomes too personal.”

Often innovation is interpreted in a narrow fashion as only applying to the development of new products. Innovation can occur across all aspects of an enterprise’s activities: how the supply chain is managed, how distribution is configured and how staff are managed.

Neville Christie, a CEO mentor and co-founder and director of entrepreneur network New Enterprise Services, says it is important to start with a definition of innovation. “We need to identify what we mean by innovation because most people seem to think that it is about product or service innovation. Increasingly, innovation is moving to various forms of intangibles – and not just patents, copyright and trademarks. A new business model, for example, is extraordinarily innovative. Going digital is innovative. So the first thing to look at is what is meant by innovation and extending the board’s horizons.”

Christie says it is important to focus on intellectual property when innovating. He cites as role models Richard Thoman, the former chief executive of Xerox and Jack Welch, the former chief executive of GE. “Only a tenth of 1 per cent of a large company’s intellectual property (IP) is known, recognised and valued. Jack Welch, in a 10-year period, focused on IP very strongly as the basis for innovation. He was able to lift the value of GE 4,000 per cent in 20 years.”

Christie believes many Australian directors do not have good training to assess innovation. “It is not surprising in the sense that the people who are typically on large boards really come from the legal and accounting professions or from senior management. And because of the risks of being in business, that focus is understandable. Maybe strategy and innovation is only given 10 per cent of the time.”

The solution, he says is to look at the composition of the board and make sure there is a balanced portfolio of directors. He categorises them as: red light, yellow light and green light directors. “You need red light directors; they are always saying: ‘Stop. Be careful’. The yellow lights say: ‘Caution, let’s investigate’. And you need green light directors who say: ‘Go, go, go’. It is all about having a good hard look at the skills and orientation of the directors on the board.”

Another option, says Christie, is to set up a strategic innovation board. The main function of the corporate board, he says, is to hire and fire chief executives. The strategic innovation board can be appointed by the CEO. Such a board takes charge of innovation so it becomes a separate entity from the board. “It is made up of external and internal people and it sits outside the existing corporate board and outside the structure of the business.”

Sue Tan, chief executive of the British corporate governance consultancy Mirason and a lecturer in business at Cranfield University in the United Kingdom, says boards should look at the end results when trying to assess the level of the enterprise’s innovation. “Are they valued by the customer? Do competitors strive to match them? Is management continually adding to the company capabilities and offerings? Can they evolve and improve?”

Innovation is always led from the top, says Tan. She stresses that it is necessary to have a senior executive who is responsible for supporting research and trialling ideas. “Innovation relies on flexible processes and systems so the company’s IT people must be capable of providing fast-track solutions. Innovation requires the assembling of good data. It also must be funded so the company must have a ‘go-to’ budget for good ideas to be tested.

“Innovation often fails to some extent, so people must never be punished for stepping outside the box and not succeeding. Managers and executives must be allowed to fail, otherwise they won’t take risks. It takes honesty. Any organisation wanting to assess if it is innovative needs to run an employee survey to answer the cultural questions, and make an honest assessment of processes, systems, practices, budgets and track record for innovation,” she says.

Australia’s oligopolistic industry structure can be a barrier to innovation. Holding on to market share, rather than finding new opportunities is often the focus with bigger corporations. Christie says most industries are made up of two or three big companies, one or two medium-sized companies, and the rest are small businesses. “Also, the size of our market is an issue. We are the size of the US, but we have the population of greater New York. So physical distribution is always a major problem.

“But with the virtualisation of business over the internet it is much easier if you focus on intellectual property; knowledge businesses, rather than product businesses. If you are able to access global markets then distribution becomes almost negligible. In the main, smaller companies are where the innovation is.”

“We have just got into the habit of bad thinking in Australia,” says Kovess. “People say they want to innovate but then add: ‘Don’t do anything that will cost us money’.” An important metric, says Kovess, is the number of suggestions made by staff. “That is all the board needs to do. How many suggestions do you get from your team members? The answer is usually maybe one a month from a team of 20.

“What happens is that employees put up their hand to their bosses to improve things and their bosses are over-worked. They have not got time to properly handle suggestions and so most employees stop making suggestions. Boards should ask: ‘How many reasoned suggestions does the board get?’ That is the evidence.”

Kovess cites the example of a hardware chain. He says the employees are required to provide suggestions each Thursday in writing to their boss about possible improvements, or about problems that need to be solved. But staff say nothing is actioned. “They said, ‘In the end, we stop reporting on the problems that are still extant. Then the regional manager thinks the problem has gone away and there is no need to worry about it.’ That is a gross failure by managers to act on insights of the employees.”

Perhaps the greatest challenge for boards is to rethink the attitude to costs. Yardley cites an instance with an employee who was considered talented but had failed and lost the company money. “A manager asked if we should fire him? My response was that he had cost me $100,000. The last thing I wanted to do was fire him. He owed me $100,000. It got a laugh, but I was serious. I said [to the employee]: ‘You owe me money: how are you going to pay it back? I am prepared to invest in you.’”

Perhaps more boards would be wise to take a similar approach to help encourage innovation in their operations.