Protiviti and North Carolina State University’s Enterprise Risk Management Initiative conducted a global survey involving 275 board members and executives across multiple industries, one of the top 10 risks cited was that resistance to change may restrict an entity’s ability to make necessary adjustments to its business model and core operations. This finding is important because change is inevitable and necessary. If organizations fail to continuously improve their products, services, processes, and capabilities, they will ultimately encounter serious performance gaps relative to more adaptive competitors.
Change creates opportunities to enhance the organization and threatsthat impair enterprise value. It can also challenge the fundamental assumptions underlying a company’s strategy and business model. Organizations must embrace change, and, in this era of continuous and disruptive change, early movers are the ones most likely to survive and prosper.
Identifying Incremental Change
Correctly diagnosing the opportunity or issue precipitating the need for change is the most important aspect of this process. If managers are confident in the diagnosis, they can then allocate the appropriate resources to address the needed change.
Changes in the business environment come in small and large doses. Small doses usually result in incremental improvements in business processes. These improvements may address new laws and regulations, contracts and internal policies that create additional corporate requirements. Alternatively, they may focus on improving customer and employee satisfaction levels. Whatever the drivers, it leads to continuous improvement in processes that achieve business objectives.
It is also important to focus on larger, root causes of change, the situations that are likely to lead to undesired consequences or outcomes. Root causes include external factors such as emerging technological trends or opportunities to improve products and services. They can also be internal issues such as poorly written policies, process failures, or inadequate training.
Performing a root cause analysis can identify the factors that drive undesirable performance. Once an opportunity or issue is fully understood and defined, relevant data is gathered and evaluated, possible underlying causes are identified and systematically reduced, multiple interrelated causes are considered, and corrective actions are formulated to eliminate those root causes. Actual results are then monitored over time, and the technique is applied again until acceptable results are achieved.
Identifying Disruptive Change
Today, managers face disruptive changes to business models and even entire industries. Whereas disruptive innovations may have once taken a decade or more to transform an industry, research shows that this timeframe is compressing and continues to shrink, leaving very little time for businesses to react. Sustaining a business model in the face of digitally enabled competition requires constant innovation to stay ahead of the change curve.
There are powerful forces reshaping our world, forcing leaders to rethink the assumptions underlying decisions relating to consumption, resources, labor, capital, competition and more. According to No Ordinary Disruption: The Four Global Forces Breaking All Trends, there are four great disruptive global forces that, collectively, are shaping a radically different world:
The shifting locus of economic activity to emerging markets. Nearly half of global gross domestic product growth between 2010 and 2025 will come from 440 cities in emerging markets, 95 percent of which are not currently well known to the Western business world, e.g., places like Surat, India, Foshan, China and Porto Alegre, Brazil, each of which is expected to contribute more to global growth between now and 2025 than Madrid, Milan or Zurich.
Acceleration in scope, scale, and economic impact of technology. The growth in processing power and connectivity through technology has been exponential. There is also the concurrent data revolution, which delivers unprecedented amounts of information to consumers and businesses in increasingly convenient ways, spawning new ways of analyzing data, doing business and fulfilling customers.
Changing demographics. The human race is aging as fertility falls as life expectancy rises. In 2013, about 60 percent of the world’s population lived in countries with fertility rates below those needed to replace each generation. The consequences of this trend include stagnant growth in a consumer-driven economy, dramatic escalation of the war for talent, and the prospect of a smaller working population supporting a larger, aging population.
The world is becoming more connected through trade and movements in capital, people, and information flows. Interconnectedness matters because it is changing the competitive landscape. Well-established incumbents must prepare for entrants from anywhere, build new global ecosystems and become more agile.
To stay ahead of the disruption curve, business leaders must quickly discern the vital signs of change and the related implications to their business model. To do that, they must do these four things well:
Understand the critical assumptions underlying the business model.
Apply contrarian analysis to evaluate plausible and extreme events or combinations of events that could invalidate one or more critical assumptions.
Conduct competitive intelligence activities focused on the vital signs.
Distill timely information about assumptions, scenario analyses and intelligence-gathering, and report insights obtained to decision-makers.
The implications of transformative market trends can be highly disruptive to established business models. In this environment of constant change, the status quo has no future and is constantly “on the clock.” Executives and directors need confidence that they have the insights necessary to recognize the effects and implications of the profound sea change unfolding before them.
Acting on Change
Having time to act is a precious asset and is available only when performance issues, market opportunities and emerging risks, and an understanding of their implications to the enterprise’s business model are anticipated and evaluated in the cool of day rather than the heat of the moment.
Unfortunately, time to act can be squandered. Decision makers need to innovatively act on their knowledge of emerging opportunities or risks; otherwise, their knowledge is useless. To ensure timely reaction, management must:
Foster an organizational culture that facilitates sourcing the root causes of subpar performance and consideration of the impact of changing market realities on critical business model assumptions. Empowering process owners and stakeholders can drive continuous improvement of business processes when subpar performance and/or trending metrics signal change. With respect to changes in the marketplace, continuous conversations around business areas, alignment of incentive compensation with short- and long-term performance goals, senior management involvement, and an active board help shape a culture that encourages understanding of the reasons for and implications of change.
Incent managers to translate root cause analysis into actionable revisions to strategic business plans and to process improvements. Incentives skewed to maximize revenues without fostering sensitivity to changing market realities can create serious organizational blind spots.
Seek organizational resiliency. When companies don’t respond to disruptive change, it’s usually because they don’t have a single version of the truth of what’s happening in a rapidly changing business environment. This dysfunction can arise from incentives that do not encourage resiliency and from management being out of touch with the customer and uncommitted to managing by fact.
Facing change with confidence means accelerating the decision-making process regarding actions to address recognized performance issues, market opportunities and emerging risks. What separates winners and losers in managing disruptive change is the ability to recognize the vital signs and act on them with confidence.
Managing the Change Process
Improving products, services, processes, and implementing new strategic initiatives requires focused and disciplined approaches consistent with the organization’s structure, culture, and operating philosophy. To accomplish this, executive management must have buy-in from a committed chief executive officer and must demonstrate unwavering support for undertaking action plans that create and sustain momentum for change. With executive management’s assistance, the change implementation team must develop a business case that clarifies why change is must happen, focus on the “big picture” with a compelling shared vision, set realistic goals, develop a clear plan of action, and make periodic use of management checkpoints.
In addition, key stakeholders—such as line-of-business leaders, operating personnel and process owners who will be most affected by the change—must own the implementation of change. Their buy-in is obtained first through evidence of executive management support. They also need to be convinced that their interests and the interests of the enterprise in effecting the change are inextricably linked.
Once the support of key leaders throughout the organization is obtained, the implementation team should establish accountability for results; focus on the human side of the change effort; align organizational, process and individual performance measures; and align the change process with the firm’s culture.
If the above practices for enabling change are executed effectively, they lead to sustainable change with confidence of achieving expected results.
Questions for Boards
The following are some suggested questions that boards may consider, based on the risks inherent in the entity’s operations.
When framing the real opportunity or issue precipitating change, is the board comfortable that management considers the business context, understands root causes, and manages by fact? Does management mitigate the effects of bias on the fact-gathering and analytical processes leading to identification of the real change opportunity or issue?
Does management recognize and anticipate the root causes of unacceptable performance? Does the organization monitor the vital signs of new market opportunities and emerging risks arising from disruptive market forces? Does management act on knowledge of needs to change in a timely manner?
Once there is commitment to act, does the organization have an effective change enablement process that drives its key personnel from awareness to buy-in to ownership to give management and the board the confidence that the change is sustainable?
Jim DeLoach is a managing director with Protiviti, a global consulting firm.
Change is a double-edged sword. It presents an opportunity to take a business to another level. Conversely, it can be a sign of the beginning of the end. Whichever side of the change curve management and the board find themselves, few would disagree that disruptive change itself cannot be taken lightly. The key is embracing its inevitability.
One of the classic works of business literature is former Intel CEO Andy Grove’s Only the Paranoid Survive: How to Exploit the Crisis Points That Challenge Every Company, published in 1996. In the book, Grove coined the term “strategic inflection point,” which he defined as “a time in the life of a business when its fundamentals are about to change.”
That a company can be the subject of a strategic inflection point but also the cause of one is a sobering market reality. Nearly 20 years later, Grove’s premise is as applicable today as it was before the turn of the 21st century, if not more so. As he so eloquently observed: “The ability to recognize that the winds have shifted and to take appropriate action before you wreck your boat is crucial to the future of an enterprise.”
“Half-life” is the amount of time required for something to decline to half its value as measured at the beginning of a stated time period. Intuitively, everyone recognizes that the half-life of virtually everything—knowledge, product life cycles, product design cycles, new technologies and speed to market—is compressing and has been for some time.
But the accelerating pace of change is old news. What we’re facing today is disruptive change to business models and even entire industries. Whereas disruptive innovations previously may have taken a decade or more to transform an industry, research shows that the elapsed time frame has compressed to half that time. Furthermore, that time frame continues to shrink, leaving very little time for reaction. Sustaining a business model in the face of digitally enabled competition requires constant innovation to stay ahead of the change curve. And eventually, the business model itself runs out of steam.
Innovation can touch many things. It can dramatically improve quality, time, and cost performance to create superior products and services for customers at affordable prices. It can create new markets, extend a product range, or replace products and services. It can be disruptive if it improves a product or service in ways that the market does not expect, typically by lowering price significantly, or by designing a product or service that transforms the way in which the consumer’s needs are fulfilled. It can disintermediate intermediaries within the value chain that links producers and customers (e.g., when Internet-based businesses use the World Wide Web to eliminate middlemen and sell their products directly to customers). Facing such change with confidence is the only viable alternative to becoming victimized of innovation.
To stay ahead of the disruption curve, an organization must first quickly discern the vital signs of change. This is a matter of the company being able to do four things really well:
Understand the critical assumptions underlying the business model. Management’s assumptions about markets, customers, competition, technology, regulatory behavior, and other external factors fundamentally shape the organization’s strategy. Because the organization’s business model is typically designed to function within the business environment envisioned by management, a dramatic shift in any of these drivers would likely require an evaluation of the model’s validity.
Apply scenario analysis capabilities. Usingscenario analysis to evaluate situations in which an event or combination of events could invalidate one or more critical assumptions helps management to understand and identify the factors that can most impact the failure or success of the business model. It helps focus attention on the potential sensitivity of changes in any of the fundamental business model assumptions. For example, industries that lack strong entry barriers may be especially susceptible to technological shifts; therefore, they are more likely to face new and unexpected sources of competition.
Conduct competitive intelligence activities aligned with the most important drivers. To facilitate the timely recognition of change, the competitive intelligence function ensures that there are mechanisms in place that enable managers to take a fresh look at the organization’s processes and customer interactions and re-examine and challenge assumptions underlying the business model as the market changes. The function aligns its activities with the most critical assumptions by offering relevant perspectives and insight about evolving conditions through a wide range of quantitative and qualitative measures. Thus, competitive intelligence creates enterprise-wide transparency by seeking out nontraditional information and data that may offer decision-makers a contrarian view.
Distill timely information about assumptions, scenario analyses, and intelligence gathering and report insights to decision-makers. Executive management must receive timely, quality information regarding customer behavior and what elements of the customer experience work well—and which ones don’t. This information must be unfiltered, meaning it must be received directly from customers to provide an accurate view of their experiences interacting with the organization and its offerings. For example, are customers remaining loyal to the company, or are they “one and done”? Do we know what drives those behaviors?
Time to act is a precious asset in a dynamic environment. It arises from timely recognition of signs of change and enables management to confidently capitalize on critical opportunities and risks arising from disruptive change.
Recognition is made possible through transparency. However, there are two “transparency killers” that can lead to strategic error:
Unduly relying on the past in predicting market behavior
Allowing silos to constrain the depth and breadth of enterprisewide communication
If hierarchical and siloed organizational structures filter information moving up the management chain, delays and distortions of the message are likely to occur. Silos tend to compartmentalize information such that relevant information gathered by one business unit may not be shared with other business units. Thus, there will be an absence of timely discussion about market conditions between business unit leaders and executive management. The result is the potential for isolated decision-making and, even worse, multiple versions of the truth.
As important as recognition is to managing disruptive change, it isn’t enough. Timely reaction must follow. Having knowledge of an emerging opportunity or risk without undertaking a process to convert that knowledge into hard choices and actionable plans to innovate processes and offerings is as useless as having no knowledge at all. To ensure timely reaction, management must:
Foster an organizational culture that facilitates consideration of the impact of changing market realities on critical business model assumptions. Continuous dialogue between business areas, alignment of compensation and other incentives with the goal of balancing short- and long-term performance, senior management involvement, and an active board help to shape the desired culture. Trending metrics that raise warning signs help to engage a diverse group of stakeholders who understand the customers, the strategy, the direction of technology, and the evolving marketplace to evaluate the signals, formulate ideas, and recommend how to proceed and where to experiment going forward.
Incent managerial ingenuity to translate altered assumptions into actionable revisions to strategic, business and product plans. Compensation arrangements that skew incentives to maximize revenues without fostering sensitivity to changing market conditions can create serious blind spots in any organization. To illustrate, if signs of vulnerability arise—such as next-generation innovations offering diminishing improvements—and are ignored, that’s a problem. If process and product owners have difficulty identifying new ways to enhance offerings, that’s another sign of trouble. If feedback from customers indicates that alternative offerings are increasingly acceptable to them, then disruptive change is brewing. If there are no incentives to question the durability of the business model, then the road traveled leads to a dead end when obvious market pressures and declining financial results force acknowledgement that the business model is stagnant. By that time, it’s either too late to salvage the business model or the process to change the model becomes more painful than it needs to be.
Seek organizational resiliency. The ability and discipline to act decisively on revisions to strategic, business, and product plans in response to changing market realities are the hallmarks of a resilient organization. Insulation from reality in a rapidly changing environment is lethal. We often hear the trite observation that management needs to ensure that the right information is given to the right people at the right time. To position the organization as a resilient early mover, this simply means that decision-makers must be in direct contact with the unvarnished truth. Armed with knowledge of the truth and supported by the board, they can apply the right tools to analyze information for decision making with a bias for the action needed to sustain superior long-term performance. When companies don’t respond to disruptive change, it’s usually because they don’t have a clear view of the truth. This dysfunction can arise from either incentives that do not encourage resiliency or management simply being out of touch with the customer.
In business environments exposed to disruptive change, adaptive processes are needed to alter underlying assumptions rapidly to reflect newly changed circumstances. Disruptive change simultaneously presents one of the biggest opportunities and risks a company can face. What separates the winners from the losers in facing change with confidence is the ability to recognize the vital signs and act on them decisively.
Questions for Boards
The following are some suggested questions that boards may consider, based on the risks inherent in the entity’s operations:
Is there a common understanding between management and the board as to the critical assumptions underlying the enterprise’s business model?
Is management periodically evaluating changes in the business environment to assess the related impacts on assumptions inherent in the business model? Is there a process for challenging the durability of the business model?
Does the organization monitor key factors that provide insight regarding the continued validity of key assumptions underlying the business model?
Does the organization have adaptive and experimental processes to address the opportunities and risks associated with disruptive change and to drive innovation in its processes and offerings?
Jim DeLoach is a managing director with Protiviti and works closely with companies to improve their board risk oversight, including the communications between management and the board. He is a member of Protiviti’s Executive Council to the CEO and was named to NACD Directorship’s 2012 list of the 100 most influential people in corporate governance. Protiviti is a global consulting firm that assists board members, and the companies on which they serve, in protecting and enhancing their enterprise value by solving critical business problems in the areas of finance, technology, operations, risk and internal audit.