Setting a Strategic Course

When corporations reach a crisis point, their boards are often criticized severely for not having been more active, for signing off on poor strategy, and for being unaware that the company was flailing.

While there has been a lot of talk about boards being more involved in strategy in recent years, nonexecutive directors remain reluctant to play a more strategic role in most companies. Of course, there are plenty of reasons, both abstract and practical, why boards shy away from having a stronger voice in the strategy process. Boards often lack the time to focus on strategy, and there is rarely a clear mandate as to how they should contribute to the development of the business strategy beyond approving the CEO’s plans. Indeed, they may fear being seen as both judge and jury should they participate in strategy development. Boards tend to lack an understanding of what a more strategic form of governance entails, and therefore also lack the know-how, competencies, and tools essential to help companies navigate strategic challenges.

If boards are to live up to their fiduciary duty to safeguard the best interests of the company, is it possible for them to determine, in real time, whether their companies’ strategies are in crisis and intervention is called for? Are boards ready and capable of intervening constructively in the strategy process, rather than further contributing to value destruction?

Recognizing the Growth Curse

One of the biggest challenges for boards working to overcome the hurdles to long-term sustainable growth is the destructive short-termism of the “growth curse.” Many investors have come to expect continual growth, even though mature companies’ underlying growth naturally slows. Even the best-intentioned CEOs can fall into the trap of creating a culture in which “meeting the numbers” becomes management’s raison d'être. Their focus is on delivering short-term financial results—or the illusion of growth.

Yet this type of growth comes at a devastating cost: It’s a distraction from developing genuine value-creating strategies. It weakens the company, making it less resilient in the face of disruption and inflection points. Additionally, it ironically hastens a company’s decline by directing resources and energy to shoring up the illusion of growth instead of building capabilities to redirect the company toward genuine new growth opportunities.

There’s No Smoke Without Fire

When a company’s strategy is driven by the short-termism of the growth curse, there are plenty of signals to alert the board to the fact that the company is rapidly heading toward trouble.

Share buybacks. These can be used to manipulate quarterly performance targets as they inflate earnings per share and increase a company’s share price. Unless the company has excess cash after investments, a strong balance sheet, and free cash flow, and times the transaction when its shares are not overpriced, buybacks will destroy value. Take General Electric Co. (GE): In the 10 years prior to the end of 2017, GE spent almost $54 billion buying back shares at an average of $26 per share. By the close of trading at the end of the following year, GE’s share price was $7.28, and the company had little cash left to undertake the restructuring it needed.

Acquisitions. Large numbers of acquisitions and divestments should send up a warning flag. They can hide lackluster performance as they usually bolster the bottom line for a few years. However, most estimates put the failure rate of merger and acquisition activity creating real value at somewhere between 70 percent and 90 percent, so they can be expensive and distracting. And they also make measuring the performance of continuing operations more difficult.

Accounting manipulations. These misrepresent financial results through earnings management and selective disclosures and can fall on the spectrum from borderline unethical to illegal. While the latter instance may be difficult to spot, boards should question any changes in accounting practices that look suspicious.

Cutting strategic costs. Cutting areas such as research and development (R&D), marketing, manufacturing process development, and training is an obvious sign of trading a short-term financial gain for longer-term decline.

Operational focus. Under the pressure of short-termism, CEOs and leadership teams become less focused on the difficult and complex arena of strategy setting. Instead, they retreat into the simpler world of operational efficiency, where quick wins have a more immediate and positive impact on performance ratios.

Boards that recognize any combination of these symptoms have limited options beyond changing the company’s leadership and signalling to shareholders that a new CEO will be brought in to pursue more robust growth strategies.

Assessing the Strategy Process

Even without obvious symptoms of short-termism driving strategic thinking and management actions, this doesn’t necessarily imply that all is well, as a breakdown in the strategy process generally precedes a financial crisis by five to ten years. For instance, when IBM Corp.’s profits hit a record high in 1989, no one imagined that the company would be on the brink of collapse two years later. Nokia’s high-profile demise came only five years after it posted its strongest results ever. Had the boards of these companies known what to look for, they would have found that both companies had been in the midst of a strategic crisis long before their financial woes became apparent.

The sustained appearance of financial success must be questioned—it’s a lagging indicator. Understanding the quality of the strategy process and strategic decision-making is much more revealing. Putting these under the spotlight enables boards to gauge the strategic health of the company. Problems and weaknesses identified early can then be dealt with internally without the need for radical action or alarming shareholders. But boards also need to understand the evolution of strategic failure and the warning signs to watch for.

Failing strategy process. This is the first step in the evolution of strategic failure. At a high level, this can be assessed by the board by asking a few simple questions:

• Are the CEO and executive team internally or externally focused? A healthy external focus on new opportunities, new markets, new customers, new partners, and new suppliers indicates a growth mind-set. In contrast, an internal focus on efficiency often indicates hubris under which strategic assumptions are rarely challenged. The company becomes blind to changes in its environment, and risks are underestimated or ignored.
• Are discussions between the board, CEO, executives, and management candid? Open dialogue about the future direction of the company, the industry, and the potential threats both face, and general sense-making of what is happening in and around the company are a sign of a healthy strategy process.
• Is the culture collegiate or combative? When the CEO and executives work as a mutually dependent team, they encourage collaboration throughout the company. However, when business units are pitted against each other, personal rivalries develop and factions form around individuals.
• Are new opportunities framed through the lens of the current strategy? This is a greater risk when there is a dominant core business. It can result in strategic opportunities being overlooked and unrealistic targets being imposed on new ventures.

Poor strategic decisions. A breakdown in the strategy process leads to poor decisions that favor continuity over renewal. Executives hide behind procedures and routines rather than voice alternative views, and the leadership team seeks out and interprets information to support their entrenched orthodoxies. Decisions are more likely to be influenced by excessive path dependence, or “creeping commitments” from past decisions: even though these commitments no longer make sense for future strategy, managers are psychologically bound by them and the company is financially and organizationally tied to them.

As executives shift their focus more toward shoring up the current dominant business, inflection points are likely to be missed. This can lead to further bad strategic decisions as management scrambles to play catch-up.

Strategy crisis. By this stage, it will be clear internally that the company is out of step with the reality of its industry, even though the outside world may not yet be aware of this. CEOs are likely to undertake unnecessary (and disruptive) reorganizations believing that new structures, rather than a new strategy, will provide a panacea to the company’s problems.

The relationship between executives and the board will also be in crisis. Members of the executive team will rarely and only reluctantly communicate with the board. With the CEO being left as the primary conduit of information to the board, it is unlikely directors will get a real sense of quite how perilous the company’s strategic position is.

Senior executives and managers who are in the know will leave the company, and those that remain may sell their shares in an attempt to get out before the inevitable financial crisis hits. Morale will be low and attrition rates high throughout the company resulting from cuts in training, expenses, and facilities maintenance, coupled with relentless pressure to meet unfeasible targets.

How Boards Can Intervene

To what extent should boards be involved in strategy, and how can they intervene effectively? There’s a potential conflict of interest when an independent board is too deeply involved in the very strategy they sign off on. On the other hand, strict adherence to the separation of board and management in strategy-setting deprives management of the valuable experience and insight brought by directors.

There is a very clear and obvious separation between the strategic responsibilities of the CEO and the board. With the average CEO tenure at around five to six years, it makes sense for the CEO to be focused on developing and executing strategy as a sequence of practical steps toward better performance in the short to medium term. After all, few CEOs are genuinely motivated by long-term considerations.

The board should be the architect of the company’s strategic direction—in other words, the strategy space and business model a company will pursue in the long term and with which the CEO’s actions need to be aligned.

The strategic direction is about identifying, articulating, and describing the underlying logic of a company and its long-term ambitions. Without an agreed strategic direction (particularly in times of disruption or maturity), the CEO’s strategy-setting risks becoming little more than a succession of short-term goals and moves that fail to address the real challenges the company is facing.

Defining the strategic direction of a company to support long-term value creation requires an understanding of the dynamics of the industry: the players, value chain, ecosystems, potential areas of convergence, markets, technology trajectory, and regulatory issues. It calls for foresight to anticipate disruptions and inflection points, as well as new technologies and emerging trends.

The company’s strategic assets also play a critical role in defining the strategic direction. Any imagined long-term ambition must be rooted in the reality of what is achievable given the strength of these strategic assets. Built over time, strategic assets include a wide range of intangibles such as R&D, brand, and logo. They are embedded in collective know-how, capabilities, management and business processes, culture, employee commitment, and talent management. As complex ecosystems have become more important in recent years, so too have relational and network-embedded strategic assets with customers, suppliers, partners, and complementors. A strategic direction that leverages and repositions existing strategic assets is much more realistic than one based on trying to acquire and build new ones.

There is a danger that the knowledge and insights gathered to inform the strategic direction (on industry trends, foresight, and strategic assets) could be interpreted and framed by the dominant logic of the company, its existing business model, and inertial trajectory. Avoiding this calls for every member of the board to be open to challenging their own beliefs, commitments, and assumptions. Seeking out experts with different perspectives can help strengthen this process, as can creating “red teams” from within the company tasked with asking difficult and provocative questions.

When the board sets the strategic direction, its role shifts from one of relative reactivity in approving the CEO’s strategy to one that is much more proactive:

• The strategy process becomes more iterative with an interplay between the strategic direction (which will be dynamic and may need adjustments over time given external developments) and the CEO’s strategy, which both fits the strategic direction and addresses more immediate challenges.
• A more strategically involved board will provide a natural “sparring partner” for the CEO to test ideas and seek input, leading to a stronger shared commitment to strategy.
• Having deeper knowledge, directors can ask more probing and critical questions to scrutinize the CEO’s strategy and whether it makes sense based on the strategic direction of the company.
• As the custodians of the strategic direction, the board can alert management to possible external risks and internal weaknesses.
• The board is in a stronger position to collaborate with management to navigate through significant change and renewal.
• In diversified companies that run the risk of pursuing too many different goals as business unit strategies and corporate value-adding strategies differ, a board that is responsible for the overall strategic direction of the company can ensure resources are focused on strategic coherence across the portfolio.

Is the Board Ready to Intervene?

Knowing what the board can do to make a more positive contribution to the strategy process, value creation, and the longevity of the company is one thing; understanding how the board can do this—what skills, knowledge, and behavior they need—is another.

The importance of strategic minds. Despite the knowledge and experience they bring to table, directors must also be especially skilled strategists and have what we call “strategic minds” to be effective guardians of the company’s future.

Having observed and studied everything from great to mediocre strategists over many decades, we have put together below what we believe are the key traits underlying a strategic mind:

• Cognitive flexibility. This skill requires us to move beyond interpreting the world through our established mental frameworks to recognize, interpret, synthesize, and see the significance and relatedness of things that are unfamiliar and difficult to perceive.
• Nonlinear thinking. While linear thinking is important in operational settings, nonlinear approaches, such as systems thinking or associative thinking, produce more creative outcomes. Strategic minds can consciously employ free association, linking multiple inputs with existing knowledge to see how small changes in complex systems can lead to dramatic effects.
• Tolerance for ambiguity. Ambiguity makes us uncomfortable as it reduces our sense of control. Yet the ambiguity from competing points of view, contradictory inputs, and complexity is a fact of life. Strategic minds accept that control is illusory and remain open to multiple hypotheses about changes they observe.
• Ability to tackle hard problems. Most people avoid hard problems and, when they can’t be avoided, resort to cognitive simplification, or recasting the problem so that preexisting hypotheses can be applied. Yet by being cognitively flexible, using nonlinear thinking and accepting ambiguity, the most difficult problems can be faced.
• Ability to see the big picture. Strategic minds are intuitively more drawn to and influenced by the big picture than to isolated events. They cultivate a wide set of relationships and seek out knowledge and understanding across multiple different disciplines and fields.
• Consummate questioning. With seniority, we are expected to provide answers. Yet strategic minds are constantly asking questions to enable them to broaden their understanding, challenge potential biases, and help others see new threats and opportunities.
• Mindfulness and sense-making. Ideas and assumptions need to be continually challenged and refined as new knowledge or experience comes into play. But being highly perceptive isn’t enough; abstract ideas and perceptions must be translated into actionable frameworks that make sense to others.
• Self-awareness. The very essence of having a strategic mind means actively seeking to challenge your own worldview and assumptions and consequently your own identity and power. It takes a high level of self-awareness to be able to continually and openly question the context within which you operate and get others on board with new directions or ideas.

Deep and broad knowledge. Being more involved in strategy requires boards to have the right balance between deep knowledge and diverse knowledge. In boardrooms, like elsewhere, “T-shaped” skills (displaying both breadth and depth) are highly desirable.

It can be a challenge to balance deep, expert knowledge and experience (the vertical bar of the T) with an ability to understand, appreciate, and be critical of others’ expertise and contributions (the horizontal part of the T). Too much director similarity in depth can lead to individual contributions becoming redundant, and not having enough breadth can lead to a lack of mutual understanding.

So, the question is, Does each director bring depth in one particular area and enough breadth of knowledge to relate usefully to their fellow directors and contribute to a collective process?

Board unity. The ability of the board to work as a unified group is vital if it is to play a more strategic role. The board needs to rally around common interests, shared values, and a keen sense of purpose. It must be aligned to present a united front and commit to a clear strategic direction both to executive management and the investment community.

But like any other group, boards are vulnerable to the emergence of cliques and subgroups, which form easily enough through shared committee appointments, friendships, or common ties. Status can come into play even in the most senior echelons, making it difficult for new or more junior directors to challenge senior directors and question the decisions they endorse. As a result, there is a danger of norms of consensus and groupthink taking hold.

Achieving unity in the boardroom requires open and honest dialogue without fear of losing face or retaliation. The goal should never be to win an argument, but for the board to converge around an agreed point of view. It does not matter what tools the board uses to support dialogue as long as the outcome is a collective commitment to the decision and the decision-making process.

If boards are to play a more active role in safeguarding the future of the companies they serve and helping them avoid the growth curse, then a more strategic form of governance is essential. With the right skills, knowledge, and intervention, boards can reduce the risk of nasty strategic surprises and contribute decisively to growth and value creation. ■

This article is from the Summer 2024 issue of Directorship.

This article is based on principles discussed in Doz and Wilson’s recent book, Escaping the Growth Curse: The Path to Stronger Corporate Strategy. They also are the coauthors of Ringtone: Exploring the Rise and Fall of Nokia in Mobile Phones.

This article is from the Summer 2024 issue of Directorship.