I wrote an article for the most recent issue of Company Director magazine on seven ways boards can support and drive innovation.

The slightly edited final version is on the Company Director website. The full original text is below.

How Boards Can Support and Drive Innovation

One sixth of Australian businesses with a turnover of over $10 million in 2014 did not exist four years later. In some cases that was due to classic reasons such as cashflow management challenges, over-extension or project mis-management. However an increasing proportion of corporate failures is due to insufficient response to changes in the operating environment, including rapid technological progress, shifts in social attitudes and consumer behaviour and disruption from new business models.

The primary responsibility of the board is the long-term sustainability of the organisation in achieving its objectives. It is a truism that those organisations that remain the same in a changing world will inevitably be left behind. Innovation – literally the making of the new – is essential not just to survival, but to any sustainable success.

Driving continual organisational renewal is challenging for directors who are also responsible for oversight of risk and compliance, as all innovation necessarily entails risk. However the biggest risk in a changing world is in not taking risk and swiftly becoming irrelevant. A true risk-averse mentality includes assessing potential risk from disruption or simply being out-competed by faster and more nimble rivals, and having the courage to undertake initiatives with uncertain outcomes to keep ahead of change.

Innovation is hardly a new issue. Yet to be effective boards often need to explicitly support and drive organisational innovation. There are seven domains that boards can address to become highly effective at innovation.

Framing innovation

Innovation can be many things. Boards need to understand and frame the kinds of innovation that are relevant for the organisation, and decide on their priorities.

There are many useful frameworks for innovation that are publicly available. A very useful exercise for any board is to select the frameworks that are most relevant for determining and communicating innovation priorities. Simple frameworks such as Nagji’s Innovation Ambition Matrix, McKinsey’s three horizons model, or Doblin’s 10 types of innovation can help clarify priorities and roles for innovation

It is particularly valuable to develop pertinent internal frameworks as a reference point for innovation activities. The Technology and Innovation Committee of Salmat’s board oversees the development and use of a proprietary innovation framework to guide its innovation activities.

Clarifying risk appetites

Innovation by necessity involves risk. Boards need a reference point for their discussions on the risks they are willing to take to create long-term value, and how they may be changing in response to an evolving business environment.

While most boards of significant organisations have a risk appetite statement (RAS) in place, this is often not specific enough to inform decision-making on innovation initiatives such as product or market extension or business model shifts, or may need to be updated to address changed conditions. In many cases RAS clearly define risks the organisation will not take, but do not give clear insight into the degree of risk the organisation does have the appetite to take.

The board of utility South East Water, which has won global awards for its innovation, reworked its RAS to be clear on where there is zero appetite for risk, such as water quality, and uses a sliding scale to indicate risk appetite for specific categories of ventures and innovation. This delegates authority risk-taking so many innovation initiatives do not require explicit board approval as long as they fit the frame. Oxfam Australia’s RAS specifically says that it has a “high risk appetite” for innovation, helping frame board decisions.

Defining innovation strategy

Every significant organisation should have clarity on the role of innovation in achieving its purpose, and how it will support ongoing renewal. Many elements of an effective innovation strategy reside at management level, however important aspects require board input, and the overall innovation strategy should be approved by the board.

Key elements of a useful innovation strategy include the role of innovation in the organisation’s overall strategy, prioritisation of innovation domains (e.g. product/ service, process, business model etc.), processes to be established to support innovation including idea generation and venture development, structures such as roles and funding approval mechanisms, and how innovation initiatives will be communicated internally and externally.

In particular boards need to consider what measures of innovation will help them assess organisational health. Commonly used lagging indicators include proportion of revenue from new products or number of innovation initiatives that achieve set financial benchmarks. Leading indicators that track activity that may lead to later results include spending on R&D, numbers of ideas taken to testing or pace of progress of initiatives through defined stage gates.

Supporting a culture of innovation

The recent Hayne Royal Commission report underlined the responsibility of the board for organisational culture. The challenge is to support appropriate risk-taking and experimentation that drives value creation, while drawing a clear line on regulatory and reputation risks.

One of the most important ways in which boards signal their attitudes to management and staff is in their response to the inevitable failures associated with innovation. If failures are career-destroying, there will be no innovation. Boards need to be seen to support failure when it was approached constructively and useful lessons were learned.

Clearly executive remuneration models need to support innovation that drives long-term value, potentially at some expense to short-term results. Future value inevitably requires investment, of both capital and management attention. The issue of rewarding executive behaviours that support long-term value creation transcends discussions of innovation. However elements of remuneration can be tied to activities and results on innovation-related initiatives.

Board-executive relationship

One of the enduring discussions on the role of boards is where responsibility for strategy resides. Strategy doyen Roger Martin recently controversially suggested in Harvard Business Review that if the board has to develop strategy on its own, it needs to sack the CEO.

Addressing how the organisation will sustainably prosper in a changing world must be central to strategy. Shifts in technology, industry structure and consumer behaviour mean no business model can succeed unchanged over the long-term.

We already understand that strategy cannot be set in stone or remain static between annual strategy meetings, it needs to evolve in response to a shifting business environment and new thinking. As such, strategy must be co-created by the executive and board. Rather than receiving strategy as fully developed for approval or questioning, boards should ask for the thinking behind the strategy as well as other options considered

The chairman and CEO of Choice both went on innovation-focused executive development programs at MIT. This helped to give them aligned frames and language around innovation and provided a foundation for establishing a shared vision of the role of innovation between board and management. The board of US insurer Allstate holds two board strategy days: one to open-endedly explore strategic issues with management, and a separate day to make strategic decisions.

It is also the responsibility of the board to drive a long-term frame for strategy. The chairman of one of Australia’s largest fund managers asked the executive team to consider the implications of a potential tripling of the fund’s size over the next decade. This was a statement of ambition, but also raised fundamental issues of capabilities, culture and priority for the executive to consider and respond.

Board structure

Among the skills that must be represented in any board is an understanding of not just technology and its impact on industry disruption, but also experience driving innovation. While some boards have added younger, technology-savvy directors in recent years, that is rarely sufficient given the importance and complexity of the issues.

Sometimes fuller renewal is required. In the face of substantial change in the business environment and a need to build and enact a long-term strategy the owners of Port of Newcastle renewed the board, appointing innovation expert Roy Green as chairman to shift the direction of the organisation.

An increasing number of boards are establishing committees to explicitly address innovation issues, as they often require more attention than can be spared at full board level. These are sometimes titled ‘Technology and Innovation’ or ‘Strategy and Innovation’ or may even eschew the word innovation but be defined as addressing these issues.

As boards frequently must devote substantial time to current issues, it is often useful to have a standing agenda item on innovation or other explicitly long-term issues, otherwise this gets crowded out by more urgent items, leaving substantive discussion and engagement to annual strategy days.

Broadening thinking

Directors are busy people, yet a core part of their responsibility is to bring in broad and informed perspectives on current strategic issues as well as on the long-term sustainability of the organisation in a changing environment.

Individually directors can and should keep current with developments in not only their own industries and fields of expertise, but also in technological shifts and their implications. However learning is often best done as a board, to develop common language and understanding of pertinent issues.

Bringing in experts, both on specific issues currently under discussion and on very broad topics including future perspectives, technology developments and global industry disruption, can provoke new thinking and informed strategic discussions. It is increasingly common for boards to go together on ‘learning journeys’ to Silicon Valley or other centers where there are relevant examples and insights that challenge and broaden current thinking. One of Australia’s major banks used a scenario planning process involving directors and management to support long-term thinking on potential challenges and opportunities.

Directors can also learn from taking roles on startups, bringing their experience and gaining real-world insights on the nature of high-speed innovation outside the corporate world.

Taking action

Boards must explicitly recognise the essential role of innovation in driving current and future success, and that taking useful risks is required on that journey. Often the biggest risk is not driving sufficient change and renewal in the organisation.

From clear recognition of the importance of innovation, there are a range of specific actions that can be taken to ensure that boards are addressing the issues effectively, as described above. These can be central to ensuring the long-term sustainability and success of their organisations.

The prosperity of not just individual organisations but also the nation depends on our boards engaging effectively with innovation.