Of the many risks that directors should be aware of, innovation is the most complex. A corporation that invests in innovation risks failure. A corporation that doesn't invest in innovation risks annihilation due to the many threats from small startups and mega-corporations alike, in a variety of areas.
In 2020 it's crucial that the corporation's policy-makers are able to maneuver wisely and keep up with the pace of technological change which constitutes both a threat and an opportunity.
Despite the challenge, most directors, who are obliged by law to promote the company's success, lack the tools, experience and knowledge needed to cope with the challenge. The biggest victims are those who appointed the directors - the shareholders.
The Israeli Banking Supervisor's instructions underwent an important update in the form of Memo from November 13, 2018. This update obligated the Israeli banks, for the first time, to appoint directors who are skilled in technology and innovation as well as to form a committee to deal with technology and innovation. These instructions from the Banking Supervisor were based on the assumption that in order for directorates to adapt to the needs of the future they need expertise and knowledge that can't be found among most directorates, and that it is essential that the board members have an understanding of technology and innovation in order to improve the company's chances of dealing with the implications of fast-paced technological change. This is an important first step toward addressing the challenge.
A study conducted by the Australian Institute for Company Directorates (http://aicd.companydirectors.com.au/-/media/cd2/resources/advocacy/research/2019/pdf/driving-innovation-the-boardroom-gap.ashx ) shows that despite the fact that three out of four directors claim that their corporation has a vision for innovative, with most of them innovation isn't on the board members' daily agenda. 57% of the directors didn't even know how much the corporation invests in research and development. Only three percent of the directors in the study stated that they have scientific and technological expertise.
A study conducted by Harvard University (https://hbswk.hbs.edu/item/everyone-knows-innovation-is-essential-to-business-success-and-mdash-except-board-directors) among 5,000 board members reveals that only 30% ranked innovation as their primary concern. Only 21% of the directors chose technological trends as their primary concern.
The McKinsey Report (https://www.mckinsey.com/business-functions/digital-mckinsey/our-insights/adapting-your-board-to-the-digital-age) showed that only 16% of directors understood the changing dynamics relevant to the industries of the companies in which they serve. Only 17% of the directors stated that their board promotes new initiatives.
These are very low figures which should serve as an important warning sign for shareholders in corporations and a clear indication of the need to rethink who the directors are and how relevant they are to the changing world.
According to a study conducted in 2019 (https://sloanreview.mit.edu/article/it-pays-to-have-a-digitally-savvy-board/) by MIT's School of Business Management among some 1,200 companies on the stock market with revenues of over $1 billion, only 24% had directors with technological and digital skills. Corporations with directorate members experienced in the digital and technological realms were significantly more successful than the others in indices such as revenue growth, asset yield and market value growth. It was found, among other things, that profit margins among companies with technologically savvy directors were 17% higher, their revenue growth was 38% greater, their asset yield was 34% higher and their market value growth was 34% greater. Interestingly, it was found that at least three directors with experience in technology were needed in order to positively impact the corporation's performance.
An analysis of Forbes' ranking of the 50 most successful companies (http://www.oecd.org/daf/ca/Evaluating-Boards-of-Directors-2018.pdf) shows that higher-ranked companies tend to bring in more professional directors in an effort to generate extra value and surplus growth vis-à-vis the market for their shareholders. Since innovation is directly linked to company performance, it's no surprise that the world's biggest stock exchanges utilize innovation indices such as the NYSE R&D Innovation Index whose aim is to facilitate investment in America's most innovative companies.
Directors must learn the language of innovation and the global technological ecosystem in order to support a change in their organizational culture which will allow the corporation to overcome the challenges and beat the competition with surplus performance. A director doesn't have to write code, but he should be familiar with new technologies, asses their impact, understand market changes, ask the right questions and make sure the corporation quickly leverages technologies for its own benefit and adapts to these changes by allocating the necessary funds and building a relevant program for implementation.
There are a number of essential steps that will enable directors to deal with innovation optimally:
1. Advance the directors' technological and digital understanding and literacy. Guiding corporate strategy requires knowledge and understanding. A director should be in charge of an innovation committee, including raising the level of digital and technological literacy among board members so they can contribute to discussions, and make sure that the members of the corporation's management are also committed to innovation. The McKinsey Report (https://www.mckinsey.com/featured-insights/leadership/the-ceo-guide-to-boards ) , which analyzed this subject, determined that directorates should increase their digital literacy, if only so they can ask the right questions in light of the fast pace of technological innovation.
2. Taking risks. The directorate should establish clear expectations of the management regarding calculated risk-taking with the aim of promoting innovation, including fostering a culture of trial and error, accepting failure, encouraging risk-taking, encouraging the bringing up of new ideas and rewarding innovation.
3. Narrative of innovation. Develop a common language with the management and a clear narrative for investors concerning innovation, including a combination of cumulative innovation and disruptive innovation. Furthermore, the corporation would do well to publish a quarterly update for investors on the status of innovation in the corporation.
4. 30 minutes of innovation at every meeting. Innovation will be a topic of discussion at every meeting and will include: an assessment of how innovation strategy can be applied, budgeting, coping with challenges, setting innovation objectives for the management, meeting the players in the ecosystem, adapting the corporate structure for applying innovation, evaluating the status of innovation projects, meeting innovation leaders within the corporation, gauging innovation, updates on innovation strategy and more.
5. Incentives for innovation. Establish incentives for long-term innovation which will ensure that innovation is the highest priority. Incentives should be established for senior- and mid-level managers for long-term innovation, and incentives based on quarterly/biannual profit and loss statements, known to inhibit innovation, should be reduced.
6. Directorate diversification. The average age of S&P 1500 directors is 64 (https://blogs.wsj.com/cfo/2015/06/17/average-director-age-creeps-higher/), and in the S&P 500 only 2% of directors are under the age of 55 (https://corpgov.law.harvard.edu/2017/04/06/age-diversity-within-boards-of-directors-of-the-sp-500-companies/). The situation in Israel is similar, as a study of TA 125 companies (https://www.themarker.com/law/.premium-1.6574411) found that the average director among these 928 companies is a 60.5 year old man who has served in the position for about 7 years. According to Mati Aharon, CEO of Entropy Corporate Governance, a study of some 3,800 directors serving in public companies on the Israeli market shows that most of the directors are males aged 50-60 with education and experience in the fields of economy/finance and law.
This statistic isn't surprising since throughout the years there's been a tendency to appoint directors from these fields, and board members are expected to continue to attract members with a similar profile and knowledge and skills similar to their own. Therefore, in order to cope with this problem, significant diversification is needed. A study conducted by Equilar (https://corpgov.law.harvard.edu/2018/04/04/how-board-skills-vary-by-director-age-groups/) which examined 383 companies and 3,570 board members found significant discrepancies between the skills that board members of different ages bring to the table. For instance, the study found that directors aged 71+ tend to have legal and public skills, while directors aged 20-40 tend to be skilled in corporate leadership and strategy. Therefore there's a need for new, younger directors with experience in fields other than those common among the directorate. According to Mati Aharoni, one means of creating a wider circle of potential directors with professional skills and high accessibility is by using independent pools (such as Entropy's pool of directors - https://www.entropy.co.il/%D7%90%D7%A0%D7%98%D7%A8%D7%95%D7%A4%D7%99-%D7%9E%D7%9E%D7%A9%D7%9C-%D7%AA%D7%90%D7%92%D7%99%D7%93%D7%99/%D7%9E%D7%90%D7%92%D7%A8-%D7%94%D7%93%D7%99%D7%A8%D7%A7%D7%98%D7%95%D7%A8%D7%99%D7%9D-%D7%A9%D7%9C-%D7%90%D7%A0%D7%98%D7%A8%D7%95%D7%A4%D7%99/) which offers a wide variety of specialist directors combined with professional scouting processes conducted by the directors through dedicated scouting committees based on the company's needs. These processes enable companies to form professional directorates which also address needs in terms of the directors' skills, diversity and availability.
It is the shareholders' duty to encourage innovation within the corporation since without it the survival of the corporation they own is at serious risk. Turning a blind eye to the challenge won't make it disappear since the competitors won't just sit around and wait. A directorate with knowledge, skills and an organized approach to innovation will figure out how technology and innovation can serve the company's strategy or adapt it to the changing world, thus leveraging technology for the company's success over its competitors.
It seems the success of corporations at times when the rate of change is high has never been more dependent on the skills of their directors.