Freedom to Fail: Risk Appetite for Innovation

The manner that failure is embraced instead of feared in a business can improve the way the company evolves and responds to new market opportunities. At a recent NACD Master Class event, Protiviti moderated a discussion among the participating directors about making innovation work in today’s rapidly evolving and disruptive markets. The underlying premise was that the risk-reward balance of years past with respect to innovation may not be suitable in the years to come.

The big picture is one of constant change fostered by disruptive technologies. The effect of technical debt and the likelihood of waves of regulation to protect consumers from harm are also relevant considerations. This picture of continuous, dramatic change offers opportunities for innovative companies to place smart, data-informed bets. It also poses a lethal inflection point for companies embracing the status quo.

Strategic agility—the ability to improve performance and thrive amid disruption—has emerged as a critical success factor in sustaining relevance. This makes innovation the organization’s lifeblood. But the real question is why are some organizations more successful at innovating than others? For example, why do some companies have a higher percentage of revenue from products and services introduced to the market over the last two or three years than others? Why are some able to be disruptive in the marketplace while others appear to embrace status-quo thinking? What’s the secret sauce? And how does risk fit into the conversation?

These are important questions for directors. In the digital age, the board has an important role to play in strengthening and nurturing the innovation culture. To that end, the NACD Master Class discussion offered a useful road map for directors to consider.

Position the organization to pivot quickly—with resources, leadership, and capital allocations. Strategic agility is about sustaining alignment with changing business realities, including reinvented business models, redesigned workflows, and new and improved market offerings. The recent global pandemic provided an object lesson that organizations can innovate with intention more rapidly than they ever thought they could. For most companies, it was a matter of innovating out of necessity using long available capabilities. Attention to changing markets, an ability to adapt, proximity to customers, decisiveness in the face of uncertainty, a commitment to act to address new realities, and a resilient workforce enabled companies to implement sweeping changes to their processes and market offerings in a matter of days. These same attributes offer keys to driving innovation at market speed both now and in the future.

Apply an “outside looking in” approach. For example, connect innovation to customer value through a focused effort to blend customer experience data, institutional knowledge, and digital perspectives when making decisions on how best to channel emerging tech initiatives to improve the customer experience continuously. Involve customer advisory teams, a “chief customer officer,” knowledgeable subject matter experts, and field operators at the innovation “drawing table” and encourage them to challenge assumptions and point out blind spots. Meet periodically with and learn from investment bankers to discuss innovation ideas as they monitor and study industry developments. Learnings from the “outside looking in” should be condensed into easily digestible business intelligence for decision-makers.

Reach a common understanding of innovation risk appetite. The board is responsible for the preservation, safety, and growth of economic value. When focusing on innovation strategy and initiatives, risk appetite is not just about the maximum risk to take but also the minimum innovation fail rate. This means mitigating risk-averse behavior. The notion is, “If you’re not failing, you’re not learning.” So, the board should engage in continuous conversations about the kinds of innovations the company needs, including innovations pertaining to the business model, business processes, and product and service offerings. This conversation should be fed by what the company is learning about markets, customers, competition, suppliers, and regulators. Periodically, the board and management should consider whether the company is taking on enough innovation risk. How much risk is enough? Are our incentives right? Do we have the data we need? Is the fail rate too low or are we failing too slowly? Is there evidence we are penalizing failure?

Focus on the expected innovation results. The board should engage management in setting innovation policy and facilitating risk-taking. Excessive processes and controls can stop innovation in its tracks (i.e., “corporate oxygen” can suffocate a start-up). While some guardrails are needed, it is up to the board and CEO to find the balance and frame the culture that allows the freedom to run. Market intelligence centered on the customer experience can facilitate decisions on where to be a disruptor to avoid being disrupted. It helps to view innovation as a discipline that enables the organization to play defense better or offense differently.

Make innovation a data-driven core competency. The board should understand how management is nurturing and strengthening the internal capabilities conducive to an innovative culture and measuring and rewarding innovation so that it becomes a core competency. The board’s focus should embrace priority-setting, capital allocation, talent acquisition, leadership development, and top-line growth. An innovation core competency starts with data for decision-making. The phrases “data-informed” and “data-driven” do not mean relying on the data available. The focus should be on the data necessary to support the innovation process without sacrificing decision-making velocity

Fail fast to learn quickly. A higher innovation risk appetite can increase speed, provided there is a strong focus on failing fast and learning quickly. This reduces project risk by minimizing the time and resources invested in unsuccessful initiatives. It is smart to break down large initiatives into discrete manageable segments that can be evaluated quickly to learn what works and what doesn’t so that the larger initiative can progress more rapidly with confidence. The notion of failing fast should enable innovation teams to redirect efforts toward more promising solutions.

Organize the board for innovation excellence. The board should set the tone and culture for innovation. To that end, directors need to be adept at strategic thinking, abreast of the evolving technology landscape, and cognizant of how emerging technologies can impact the customer experience and the company’s talent acquisition and retention strategies. The key is to understand changing business realities, often expressed as having “currency.” Though not easy to sustain, currency is a board prerequisite to engaging management effectively in strategic innovation conversations.

Board composition is also important. For example, an analysis of the boards of US-listed companies determined that companies with boards of directors that have at least three technology-savvy members outperform other companies. But the importance of the innovation discussion is such that every director should be engaged. Too often, most people in the boardroom are not involved in the innovation strategy discussion.

In summary, taking calculated risks in an intelligent and proactive way to drive innovation and sustain competitiveness is necessary to thrive in a rapidly changing world. Innovation inherently involves uncertainty. Accordingly, not all endeavors will yield desired outcomes. Framing risk appetite for innovation is about unleashing creativity and accepting failure as a natural part of the process. The focus is on the upside of unlocking untapped potential, identifying new revenue streams, improving operational efficiency, and enhancing the customer experience. That is why board leadership on the innovation front is as important as company leadership.

Protiviti is a NACD partner, providing directors with critical and timely information, and perspectives. Protiviti is a financial supporter of the NACD.