By Martin Reeves and Lars Fæste
When Risto Siilasmaa was elevated to chair of Nokia’s board in 2012, he and fellow directors oversaw a dramatic transformation.
In response to fast-changing trends in mobile technology, they re-centered Nokia’s strategy on network infrastructure, selling its handset business to Microsoft and acquiring Alcatel-Lucent. And they installed leaders capable of leading the transformation, ultimately turning over all but one member of the executive team.
These actions led Nokia out of a severe crisis, yielding a 500% increase in market capitalization over five years.
But such dramatic reinvention isn’t easy.
Board members should base their plans on an empirically based understanding of what works and what doesn’t for the long haul.
At any point in time, about a third of all large firms are experiencing a two-year decline of 10 percentage points or more compared to peers in their ability to create shareholder value, according to a Boston Consulting Group study of more than 300 large US companies over a 12-year period published in MIT Sloan Management Review.
Often, the response to this decline is a company “transformation” – a fundamental reinvention of the firm that aims to boost performance and improve future trajectory.
However, such initiatives are risky: As few as 25% of transformation efforts succeed over both the short and long term, according to our research, and the likelihood of success falls as performance deterioration worsens. Quick, or even preemptive, action from corporate leaders – including board members – can make or break a company’s future.
The right leadership is essential
To pull off a successful transformation, it is important that a firm has the right leaders – executives with a disruptive, action-oriented mindset who are willing to make the required changes.
While undergoing a change effort, many firms and their boards engage a new CEO, who can bring the benefit of a fresh perspective. On average, firms that change CEOs during a transformation increased total shareholder return by 4.5 percentage points more than firms transforming under an incumbent CEO, according to BCG’s analysis. And new leadership beyond the CEO position can also yield benefits: Companies pursuing a transformation that changed 20% or more of the officer group increased total shareholder return by 4.4 percentage points more than firms with low turnover.
This does not imply that leadership change is the only solution. Instead, it highlights the importance of having leaders who are forward-thinking and dare to question the status quo. While a new CEO and leadership team may be more willing to stray from a company’s previous approaches, incumbent executives can also succeed if they adopt the mindset of an outsider.
Take a Long-Term view
Strategic investment in R&D is a major contributor to successful transformation efforts and long-term value creation. Firms with above-average R&D investment during a transformation effort increased long-term TSR by about five percentage points more than firms with below-average R&D investment, according to our analysis. And leaders can make R&D more effective by investing in ideas with the potential to transform the firm’s growth model in the long run, rather than incremental upgrades to existing products — a key consideration for board members when evaluating R&D projects and governing major change initiatives.
But there’s evidence that companies may be investing too little: For example, while profit margins are up 21% since 2010, R&D investment has been flat. That means many firms likely have room to increase spending in R&D and innovation that will fuel long-term growth.
Make Sure to Communicate a Compelling Transformation Plan to All Stakeholders, Including Investors
Clear communication from the board and C-suite about the goals of transformation initiatives can help establish credibility with investors and other stakeholders, which in turn can lead to better long-term performance. In fact, companies with formal, explicitly communicated transformation programs increased total shareholder return by 2.5 percentage points more than those that attempted to reinvent themselves without a formal program, our analysis shows.
Severe performance decline could be on the horizon for firms in any industry, especially in today’s volatile business landscape, and boards and business leaders should always be on the lookout for new potential competitors or market disruptions. As boards collaborate with business leaders on transforming their enterprises, they should consider these evidence-backed success factors to stay ahead of the curve.
Martin Reeves is a Senior Partner at The Boston Consulting Group and Director of the BCG Henderson Institute. Lars Fæste is a Senior Partner at The Boston Consulting Group and global leader of the BCG Transformation practice and BCG TURN.