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Innovation: The Forgotten Board Priority

By Tony Chapelle, Agenda – A Financial Times Service

March 24, 2014

In an age of flash-sale websites and instant obsolescence, most board directors understand how crucial it is for companies to avoid the risk of irrelevance. Yet directors and other experts say many boards aren’t doing enough to drive innovation.

“Innovation is a board responsibility,” says Margaret Pederson, who chairs the innovation committee at Viad, an NYSE-listed trade-show and recreation firm with about $500 million in market cap. “[Management teams] are focusing on innovation, but boards are not.”

One way, however, for a board to help oversee its company’s sustainable innovation: Create an innovation committee.

Since, as the saying goes, every public company is now a technology company to some degree, many of these bodies are known as technology and innovation committees. In other cases, the organization’s need to innovate may be married to another crucial focus. For example, at Philip Morris International, whose tobacco products are highly regulated, its board group goes by the name “product innovation and regulatory affairs committee.” Former U.S. Defense Secretary Harold Brown is the committee’s chair. Among the creations that Brown and his committee members have approved has been the strategy, research and development, and budget for Philip Morris’s “heat-not-burn” cigarette.

Regardless of how health advocates view them, so-called HnB cigarettes are innovative in several ways. The HnB cigarette is designed to not release carcinogens, which makes it much less dangerous than regular or even e-cigarettes. Although Brown says the HnB products will likely never replace cigarettes, if and when they’re approved they could command a substantial share of the market. From a marketing standpoint, they’re designed to solve an intractable regulatory problem. Brown says the company is hopeful the government will allow Philip Morris to advertise these cigarettes, something it won’t allow the company to do for burn-and-smoke or even e-cigarettes. Last January, the company announced it had invested $680 million to build an HnB manufacturing facility in Bologna, Italy.

HnBs are the newest iteration of so-called “reduced-harm” tobacco products, which tobacco giant RJR Nabisco sought to make as far back as the late 1980s under CEO F. Ross Johnson. (Johnson later complained that his company had spent $350 million to create a cigarette that tasted like “a turd with a tip.”) Philip Morris’s version — and a verdict on its taste — won’t be available until 2015.

Brown says the board at Philip Morris spends time at every meeting discussing both the defensive and offensive aspects of innovation, including new products and better manufacturing and marketing. “We hold management responsible and urge them to make necessary investments to assure that the company won’t be surprised by the competition…[or] decline because current product usage goes down and they have nothing to replace it with.”

It was Harvard Business School professor Clayton Christensen who, in a 1995 Harvard Business Review article, scared the pants off of managers and board directors alike when he coined the term “disruptive technologies.” Christensen’s warning was chilling: Doing everything right can still leave a successful company vulnerable if another company develops an innovation that changes the game with a solution that’s simpler, more accessible, or more affordable.

The list of disruptive innovations that knocked reigning technologies off their roosts includes personal vs. mainframe computers, cellular vs. fixed-line phones, and discount and outlet stores vs. full-service department stores.

But despite Christensen’s warning 19 years ago, Rita Gunther McGrath, an associate professor at Columbia Business School, says some directors and managers remain focused less on innovation and identifying potentially disruptive technologies and more on meeting key performance indicators for the current and next fiscal quarter.

“Boards need to understand the innovation agenda, which calls for concrete investments made today for tomorrow,” McGrath advises. “But a lot of boards just don’t do that.”

Pederson, the board member, says a board that doesn’t step up to oversight of innovation is leaving its company at competitive risk. When such companies — particularly in the drug, biotech, consumer products and electronics industries — don’t brainstorm new products or services, “disruptive technologies will take you over,” she says.

Ashok Vasudevan, the founder, chairman and CEO of Tasty Bite Eatables, a convenience-food producer whose products are sold in 13,000 U.S. supermarkets, agrees that not enough boards are paying enough attention to innovation.

“I don’t think that innovation percolates through all Fortune 500 companies, nor do boards have a hand in it,” he says. “Procter & Gamble is a fabulous example of process innovation. But you wouldn’t [mention] Unilever in the same breath.” Vasudevan should know — he was a product manager at Unilever and later a vice president at Pepsico.

It’s not only shareholders who want to know whether corporate leaders bake innovation into the strategic plan. McGrath says she recently heard an executive from Barclays in London tell a conference of professional service firm partners that his bank considers some companies’ capability at innovating among other risk factors when it considers giving commercial loans.

Yet the real test, according to A.G. Lafley, the chairman and chief executive officer of Procter & Gamble, is that, even though a process can be managed and measured, the key to successful innovation is a “consumer-is-boss” mindset.

Some companies such as Whirlpool acknowledge that change in the rate of innovation at the company is among the risks that could cause material harm to its future. Whirlpool lists that in its forward-looking statements.

To be sure, there are innovation committees at dozens of major companies. Some of those include The New York Times Co., Philip Morris International, Becton Dickinson, L’Oreal, Procter & Gamble and Altria Group. According to the charter for the technology and innovation committee at the New York Times, for example, that body’s job is to review and discuss with management its overall tech and innovation strategy, the tech budget, strategic investments, and R&D. The committee also makes recommendations to the full board when appropriate.

Meanwhile, proxy filings at companies including Google, Intel and Cisco Systems claim their boards are fully committed to product innovation and are willing to accept higher risk in return for greater potential reward. Intel’s April 2013 proxy, for example, said the company’s officials understand encouraging innovation and “appropriate” levels of risk-taking in their projects and processes may enhance Intel’s business interests.

The 10-member board at Viad, the trade-show firm, last year voted to form its own innovation and marketing strategy committee. CEO Paul Dykstra is one of the committee’s four members. To stay up to speed on changes across various industries, Pederson, the committee chair, attends TED conferences and reads extensively about innovation.

She says the next step is for more companies to establish procedures for innovation that are as rigorous as those that govern risk management. While audit or risk committees have well-accepted standards — some companies track as many as 122 levels of risk — there remain many organizations that haven’t systematized metrics or policies to produce new products and processes.

“We see companies that are serious about innovation creating dashboards with both outputs and inputs,” says Barrie Berg, CEO of a global innovation consulting firm called What If. “They can monitor the process and pace of efforts as well as the commercial outcomes.”

McGrath points to the Australian pallet-making company Brambles as an example of a firm that’s created metrics to keep tabs on an innovation culture. Brambles uses an organizational dashboard to assess three stages of innovation: idea creation; incubation with development of a prototype and market testing of the idea; and acceleration, or launch. The managers measure the number of ideas that have been fleshed out, the number of persons trained in the new methods and the depth of the pipeline itself.

McGrath emphasizes, however, that few managers at any company will be willing to take the risk of missing their performance or revenue targets unless their bosses are willing to pay some types of bonuses while the kinks are getting worked out of any new innovation. “It’s really discouraging when you know you’re doing something that’s benefiting the long-term future of the firm but your reward doesn’t reflect that.”

Harold Brown, who previously sat on the boards of IBM and Cummins Engine, doesn’t believe that large corporations are behind in innovation. He points out that it took “a driving CEO” such as Lou Gerstner to force IBM to make the painful innovation shift to being primarily a service company instead of focusing on hardware, as it had since its inception. Meanwhile at Cummins, the board approved a costly transformation to produce engines with reduced hydrocarbon and ozone emissions before its better-financed global competitors, including automakers such as Daimler. The company met emissions standards ahead of regulators’ schedules, which satisfied trucking owners.

Brown does, however, admit that creating an innovation culture isn’t easy. He once again invokes Clayton Christensen, who said it’s always difficult for a corporation to adopt new products or processes because employees know that improvements could reduce their standing in the organization.

“That’s why buggy whip makers went out of business,” Brown says.