Rethinking Governance for Digital Innovation

When global chemical company BASF launched its Onono lab in São Paulo, Brazil, its mission was to accelerate innovation through rapid collaboration with local partners and startups. But Onono’s director, Antonio Lacerda, faced an immediate hurdle from corporate governance: He was told that his lab would have to follow the same corporate data policies used to secure BASF’s entire cloud infrastructure — which would have made it impossible to partner quickly and nimbly with new startups. Lacerda postponed the launch until he was able, with significant political capital, to arrange an exception: a “sandbox” of separate data for his team, with special permission to share that data through APIs with new partners.

Lacerda’s experience, and that of so many innovation champions, points to a fundamental problem for digital transformation: In large companies, innovation teams are left to fight for waivers in the face of business rules that contradict their own mandate for change. But innovation will never happen at scale as long as it relies on ad hoc exceptions approved by senior leaders. Instead, we must rethink our approach to governance and design new management practices for innovation at the speed of digital.

Designing repeatable processes for innovation is essential for growth in the digital era, yet it is incredibly hard. In too many organizations, new ventures are green-lit based on a single executive sponsor. Once started, ventures move slowly, managed by teams that sit in traditional silos. Resource allocation is slow too, as promising projects wait weeks or months for their next round of approvals. Because each project is backed by an influential executive, no one wants to shut it down, even if it shows little promise.

Meanwhile, risk aversion leads businesses to fund only their low-hanging fruit — incremental improvements in the core that bring a guaranteed, quick ROI. This path will never lead to transformation. Instead, you need governance that embraces uncertainty and supports growth both within and beyond the core. (See “How Governance Helps or Hinders Innovation.”)

Digital transformation requires that governance be carefully designed to address several issues. The first is oversight. Who approves new projects? To whom do they report? And who shuts them down? Next is funding. How will you allocate resources across a portfolio of ventures to maximize opportunities for success? Equally critical are people. Who will staff new ventures, whether inside or outside your organization? How will teams be formed with the right mix of skills? Governance must also include metrics. How will you measure the progress of new ventures? And, crucially, how can you bring discipline to regularly shutting down ventures, a practice so often neglected at large enterprises?

In this article, we will discuss how to design governance models to drive digital innovation across any enterprise, by focusing on two critical work groups: the people engaged in building new ventures and those overseeing and assessing their work. We’ll delve into the top governance issues for managing growth at scale, including how venture teams and supervisory boards work together. And we will explore how to manage ongoing decisions to green-light new ventures, grant additional funding to those that merit it, and shut down others to free up resources.

Design Teams to Drive Innovation

Decades of experience have shown us that, in established businesses and small startups, meaningful new growth always starts in one place: small teams, effectively empowered. These teams do the work of rapid, iterative experimentation, which is at the heart of every modern approach to innovation — whether agile, design thinking, lean startup, or product management. Every innovation team’s job is to take a proposed new venture and rapidly test every facet of its business model to validate what will or will not work in the market.

Within any established enterprise, the rules governing innovation teams are critical to their success. Many readers will be familiar with the idea of small multifunctional teams. But size and composition are only part of what matters for team success. By studying innovation in digital natives like Amazon and Google, and digital transformers like Walmart and Mastercard, I have identified five essential pillars of team governance. Great innovation teams are:

Small. Research has shown that small teams communicate, coordinate, and make decisions much faster than large ones.1 Small teams are foundational to agile methods, which use a rapid cadence of short sprints in which every team must deliver new working code, test and learn, and adjust priorities. At Amazon, innovation teams are called two-pizza teams because each one should be small enough to be fed by two pizzas (a maximum of eight people).

Multifunctional. Great innovation teams have diverse members who cut across functional silos (for example, marketing, engineering, and design). The goal is for each team to have members who can provide all the essential skills needed to do its work. Instead of constantly waiting for another department’s input before taking the next step in its project, a multifunctional team is able to push ahead entirely on its own.

Single-threaded. The best innovation teams have all members dedicated full time to the team’s work. At a minimum, the innovation team’s leader must be single-threaded, meaning they cannot be splitting their workweek between the team’s new venture and other projects. Leading the team is their full responsibility.

Autonomous. Successful innovation teams have clear decision rights that give them the authority to work under their own direction. They should not need to get approval on their work from anyone outside the team — whether it is on product design, what tests to run next, or which customers to pursue. Autonomy also means there are no prohibitions on contracting resources from outside the company.

Accountable. Autonomy is possible only if the team is also clearly accountable for the results of its work. Here, good governance demands a clear definition of success, which is defined in terms of outcomes, not deliverables. That definition may include quantitative metrics as well as qualitative principles, and it must be agreed on with leadership before the team’s work begins. Effective accountability also requires transparency: At any time, the team’s results must be visible to anyone inside or outside the team. Every test run, every MVP built, and every metric tracked should be visible to anyone in the company.

Establish Oversight With Growth Boards

Innovation teams’ most critical partners are the managers who will allocate funds and oversee and support their work. In my experience, the most successful model for sponsoring corporate innovation is the board. In the board model, a small group regularly convenes and deliberates to decide whether to sponsor various possible innovation ventures — much like a group of VC investors listening to pitches from startups. One innovation board will sponsor and support multiple teams working in parallel.

This approach contrasts with what I have found to be all too common: organizations where new ventures are approved by a single sponsor. In these companies, one or more executives may use their clout within the organization to sponsor a new digital venture they deem strategically important and promising. This model is inherently ad hoc, with decisions based on the instincts and judgment of different individuals. And once a sponsor puts their name and reputation behind a project, it is very hard for them to let it die, no matter what market validation shows about its prospects. By contrast, the board model — with its greater diversity and impartiality of decision-making — is inherently better for managing innovation at scale.

Effective corporate innovation boards — also known variously as growth boards, venture boards, or growth councils — should number no more than eight people. They should include members with topical expertise and knowledge of the market. A board should be able to challenge company orthodoxy, advocate a long-term view, and bring in ideas from outside the industry. The best boards combine internal stakeholders from different divisions and at least one member with an external perspective. Members should be senior enough to have real clout in the organization but not so senior that they can’t make board work a priority.

The job of the board is to regularly meet to green-light new ventures, provide strategic guidance to teams, decide on each stage of additional funding, and make disciplined decisions about when to shut down ventures. Here again, decision rights are critical. The innovation board must have complete funding authority for each team in its portfolio. Its decisions should be informed by open and lively debate with the team, but the decisions remain with the board. Other senior executives, including the CEO, may advise and provide input on ventures, but they cannot vote on or overrule the board’s investment decisions.

Green-Light New Projects

The first process where boards and teams must work together is green-lighting — that is, approving new ventures to start work. When a board green-lights a new venture, it should allocate just enough resources (in the form of time, money, and people) for the team to conduct a first round of testing to validate the initial questions about the business model. The key to effective green-lighting is to minimize the initial investment made in each team and maximize the number of ideas that are approved to be tested.

This approach may seem counterintuitive — it certainly contrasts with the tendency to try to “pick a winner and bet big,” seen at so many organizations with poor innovation governance. In fact, it is important for boards to resist the urge to try to pick the best ideas among those submitted. First, the board has truly no way of knowing which ideas will work. That knowledge can be gained only through testing and validation. Second, successful ventures often emerge from ideas that are initially flawed but evolve in response to testing, feedback, and iterative design. Instead of trying to evaluate the likelihood of success, I recommend that boards judge new venture pitches based on their problem definition, strategic fit, and team mindset.

To green-light many innovation ideas, it is essential to build a fast, cheap, and effective validation process. This means bringing in the voice of the customer to rapidly test whether the venture is focused on solving a genuine problem. At Citibank, new ventures often begin with a two- or three-day workshop in which employees explore a problem/opportunity statement and have a chance to develop their own innovation ideas in a rapid, iterative fashion with actual customers. As you increase the speed and drive down the cost of your first stage of validation, your business can afford to approve more venture teams to test and pursue more possible ideas for growth.

Manage Resources With Iterative Funding

The next critical process for managing innovation is iterative funding, which is how boards allocate resources to teams after their ventures have been green-lit. Iterative funding is designed to be extremely agile, based on the VC approach to financing startups. At each board review (typically every 30, 60, or 90 days), the board will review each team’s progress, including new data from its tests in the market, and decide whether to release the next tranche of resources to that team.

Iterative funding is a dramatically different process from traditional budgeting in large enterprises. Here’s why it’s a better approach for managing investments in new innovation:

Get off to a faster start. In a traditional budgeting process, a new project will be granted a large initial sum that reflects commitment to the project. But that happens only after a long period of analysis that strives (misguidedly) to assess the chances of an uncertain new venture through benchmarks and third-party data. Iterative funding, in contrast, gives ventures a small initial budget but allows teams to get started fast, if the opportunity they are pursuing is well defined and strategically relevant.

Be more agile with shorter funding cycles. Corporate budgets are typically set annually, with projects and departments funded through a complex process that takes months. A promising new venture can wind up waiting over a year to get resources for a four-week test. In contrast, when boards meet frequently and funding rounds provide teams with just one to three months of resources, decision-making is much more agile.

Invest based on real-world data. Many leaders will overcommit funds to an untested new venture because they have a personal conviction that the strategy is right or because they are swayed by the persuasive talents of the team. With an iterative funding process, the board decides on each round of resources based entirely on real-world data. Every time they meet, the board and the team must agree on what data the team needs to bring to its next review meeting. Those metrics — typically three to six key variables — will shift over time, depending on the biggest sources of uncertainty still facing the new venture. They capture what the venture team has learned so far and what it needs to learn next.

Scale fast to drive exponential growth. In traditional budgeting, when funding is renewed, any increase is only incremental from the previous budget. With iterative funding, if validation is successful and a venture moves ahead, the size of each investment round should grow exponentially. Allocation of human resources should increase as well. This means that innovation teams that uncover meaningful growth opportunities can scale quickly to make a measurable impact on the company’s bottom line.

Clearly, iterative funding requires that boards be ready to ramp up investment quickly in ventures that prove themselves in the market. That means the enterprise must fund a pool of resources in advance, for the board to allocate over the course of a year and across a portfolio of projects.

Within each portfolio, similar innovations (for example, a portfolio of high-risk innovations within a single business unit) should compete for funds. Don’t let apples compete with oranges. First fund the portfolio for a specific class of innovations, and then let the board iteratively fund the various ventures.

Make a Habit of Smart Shutdowns

Of course, not every team review will conclude with a decision to continue funding. One of the classic problems that bedevil corporate innovation is that companies learn how to start new projects but not how to stop them. For innovation to deliver results, companies must be ready to exit projects that prove unsuccessful or are insufficiently aligned with strategy.

Shutting down ventures systematically and regularly is a critical job for growth boards. Every time a board meets for an iterative funding review, the question must be, “Do we fund this venture further or shut it down?”

At legacy companies, the biggest barrier to shutting down innovation projects is often an aversion to admitting failure and an irrational feeling that any kind of failure poses too much risk. But the cost of failures is minimal when they are shut down early, through iterative funding. In contrast, there are very real costs to the company if your teams do not shut down ventures quickly and smartly. Without this discipline, your innovation will lack focus, your resources will be spread too thin, and you will run out of bandwidth for new experiments. You will be stuck with zombie projects — unsuccessful ventures that never shut down and continue siphoning off resources. At Johnson & Johnson, an entire new series of innovations was funded by evaluating the existing portfolio and shutting down projects that no longer matched the company’s updated strategy.2

Halting projects will become easier only if you make it a routine decision, and here innovation boards with a regular calendar of funding reviews will make a huge difference. In GE’s oil and gas division, projects were rarely shut down before its board was instituted. As soon as the board began, it easily shut down 20% of existing projects in its first 90-day cycle. As the board and teams became focused on aligning to strategy, this rose to 50% of new ventures shutting down within 60 days.3 At media giant Schibsted, the goal is to remove one venture whenever adding something new to the development pipeline. When a project comes up for review, set a high bar for yourself by asking, “Why shouldn’t we shut this venture down?”

The following five practices are essential to achieving smart shutdowns in any organization:

Plan a pipeline with survival rates. Innovation at scale requires planning for most new ventures to be shut down. Only a third to a half of bright, shiny new ideas typically survive their first funding review after they’ve had contact with real customers. Survival rates typically increase in subsequent rounds. Understanding your survival rates at different stages of validation will allow you to plan a pipeline for the future. For example, if a board is expected to help bring three or four new ventures to market within a year, it needs to plant enough seeds at the start to have good odds for success.

Use a venture backlog to reassign swiftly. An innovation board should maintain a ranked list of ideas for ventures that have been approved but not yet begun. Using this backlog in your review process will make shutdowns much easier. The point is no longer simply to kill a failing idea but to free the team and its resources to work on a more promising idea from the backlog. So, when you shutter a project, quickly reassign members to the best next idea. In many cases, that may just mean refocusing that team on a different solution to the same problem.

Extract value from shutdowns. When you decide to shut down a project, look to extract as much value as possible. In some cases, a company may be able to sell the venture to another business. When Walmart’s Vudu streaming video service was no longer a strong strategic fit, Walmart spun it off to media giant Comcast. Sometimes a venture is promising but not yet workable; by shrinking your investment, you may maintain your future options. After Google Glass failed as a consumer product, the company shrank the project to an enterprise-only device focused on applications on factory floors.4 Sometimes only a full shutdown makes sense, and the key value to extract is the learning gained from experimentation. When Amazon shut down its Amazon Auctions and zShops services, it applied the lessons it learned for the subsequent launch of Amazon Marketplace to great success.

Share learning widely. Sharing what you learn from failed ventures is one of the hardest principles to follow. Most companies prefer to look away from projects that didn’t work out. In a 2014 internal report on its early digital transformation efforts, The New York Times Co. admitted, “When we do shut down projects, the decisions are made quietly and rarely discussed, to protect the reputations of the people who ran them. As a result, lessons are forgotten, and the staffers involved become more risk averse.”5 Overcoming this reluctance was essential to the ultimate turnaround of The New York Times Co. and its business model. The German affiliate of Fédération Internationale de l’Automobile (FIA) ran an innovation lab where eight of 10 projects were killed in a single year. Its biggest win? Sharing those results with other FIA affiliates around the world that were struggling with the same challenges in their own markets.

Distinguish people from projects. This is a final critical piece to building a culture that accepts and learns from innovation failures. A strong board review process will hold teams accountable for their results. But you should be careful not to associate a failed project with the merit of the individuals who worked on it. Those same team members could achieve tremendous success for you in their next project. Be sure to encourage your innovators to keep working on their next idea.

If your process for shutdowns is truly working, you will begin to see volunteering. When teams are truly focused on validating growth opportunities through experimentation, they will often suggest their own shutdown to the board, reporting, “Here’s what we have learned and why we recommend shutting down now.” Don’t be surprised when those same employees soon return to their board with another venture idea. It could be your next big breakthrough.

For digital transformation to deliver real growth and value to any organization, it must involve more than isolated pockets of innovation from teams struggling under the yoke of ill-suited management. Without new governance models to manage new ventures, the potential for digital innovation will always fall short.

Innovation governance requires three key building blocks: (1) Teams must be empowered to move fast and experiment to discover what works in the marketplace; (2) boards must be empowered to oversee and advise portfolios of teams, allocating resources where most needed; and (3) both must follow regular processes for green-lighting new ventures, funding them iteratively, and shutting them down to free up resources for the next emerging opportunity.

With the right governance in place, established companies of every kind can unlock the potential in their own employees to drive transformation and growth at every level of their business.