Many CEOs Aren’t Breakthrough Innovators (and That’s OK)22 September, 2015 / Articles
Innovation is widely regarded as important to long-term business performance. However, CEOs often don’t have the career background and education that would equip them to personally lead the process of new product development. We’ve found that CEOs of big pharmaceutical companies, for example, are more likely to have a background as company lawyers, salespeople, or finance managers, than one in medicine or pharmaceutical R&D.
So, to achieve higher performance, should company boards and investors choose CEOs with the expertise that would better qualify them to lead innovation? Our research suggests that in certain industries—where breakthrough innovation is critical for growth—they should. But in many sectors, breakthrough innovation is often not as important to performance as it’s perhaps made out to be.
We found that, for pharmaceutical industry CEOs, there is a statistically significant relationship between a CEO’s specialist background and the firm’s performance. A specialist background to lead innovation is worth a 4% better shareholder return every year for 20 years, compared to other pharma CEOs in our sample.
Of course, there are other possible explanations for this. For example, the companies that had technically qualified CEOs and performed better were often relatively smaller, which suggests that the complexity of large pharmaceutical companies may be a problem in driving R&D. Overall, it is a messy picture. There was no strong association between CEO background and firm performance in high-tech and fashion retail. And across the three industries, there were plenty of CEOs well qualified to lead innovation whose firms generated poor shareholder returns, and vice versa.
We decided to look at case histories of the 10 top-performing CEOs in pharma, high-tech, and fashion retail from our sample to understand people’s stories. (We focused on CEOs with at least five years in office.) Among these 30 CEOs, only nine (six in pharma, three in high-tech) achieved their strong performance while overseeing breakthrough innovation. For the rest, we found that other factors besides innovation drove strong shareholder returns.
In the pharmaceutical industry, short patent lives for prescription drugs mean companies must continually look for new drugs to fill their pipelines. And these often have to be significantly better than what’s on the market (in other words, breakthroughs) due to the high cost of R&D. Six of our top 10 pharma CEOs lead companies where shareholder value was directly tied to the development and launch of important new drugs during their tenure—and five of them did have a career background in pharmaceutical R&D and a relevant scientific or medical education.
The other CEOs in our sample didn’t directly oversee breakthrough innovation. Because the growth of Celgene under CEO John Jackson was tied to the repurposing of thalidomide (an old and powerful, but highly dangerous drug) to safely treat new diseases, we did not count this as a breakthrough (though it was a tough call). The three other CEO success stories, however, more clearly did not involve breakthrough innovation. For example, Brian McNamee of CSL Ltd made a series of global acquisitions to turn Australia’s small Commonwealth Serum Laboratories into the global leader in plasma products. And Michael Pearson, the head of Valeant, boosted the company’s performance by aggressively cutting R&D spend, taking on debt to finance acquisitions, and moving the company outside of U.S. tax jurisdiction. Meanwhile, Lars Sorensen was CEO of Novo Nordisk as the company’s core market, diabetes care, experienced growth beyond expectations.
In high tech, two of the top 10 CEOs created particularly high value thanks to breakthrough innovations: Apple’s development of the iPhone and NVIDIA’s development of the graphic processing unit. Both Steve Jobs at Apple and Jen Hsun Huang at Nvidia were able to draw on deep personal experience in product development to play a key role in driving these innovations. But technical background isn’t an absolute requirement. For instance, we considered Harman International’s development of the MOST (media oriented system transport) system, under CEO Bernard Girod, as a breakthrough (it established its strong position in the infotainment market), but Girod’s career background was largely in planning and finance.
Breakthrough innovations in high tech certainly have a powerful impact on performance, but they are quite rare. Most of the tech firms in our sample achieved a breakthrough innovation early in their corporate lives. But seven of our top 10 tech CEOs relied on other sources of value creation over the period we examined. For example, Qualcomm’s CDMA mobile technology was a breakthrough that led to its IPO in 1991. But it was exploiting this technology’s growth potential some years later that put Irwin Jacobs in our top 10 tech CEOs between 1995 and 2014.
Most of our top tech CEOs created value by rolling out earlier breakthrough innovations in a newly high-growth market. For example, Michael Dell developed his breakthrough model of direct-selling personal computers in the 1980s. But it was the following decade’s internet boom that made this approach attractive and gave Dell a second burst of growth. And others, like Stephen Luczo at Seagate, Michael Ruttgers at EMC, and Daniel Warmenhoven at NetApp, took off as the internet boom led to dramatic growth in the demand for computer storage.
Even though (comparatively) few of our top tech CEOs achieved their outperformance from a breakthrough innovation occurring between 1995-2014, the ability to keep up with the pace of high-tech innovation was crucial – and having a sufficient technical background matters. For example, Terry Semel, who succeeded Tim Koogle as CEO of Yahoo in 2001, had a media marketing background at Warner Brothers. Clever brand positioning and offering media services helped him sustain Yahoo’s success for a while. When Google came in with its innovations in internet search and advertising technology, Semel made acquisitions rather than relying on internal development (Inktomi for search; Overture for search keyword advertising). But these products still needed rapid further development and integration to be competitive. Without a tech education or high-tech product development experience, Semel was not well placed to lead this process. Google powered through to an unchallengeable lead.
In fashion retail, what constitutes a breakthrough innovation may be more subjective. But based on our research, we consider that not a single one of the CEOs on our top 10 list got there because of a breakthrough innovation during our period of study. Most often, what led to their success was a strategy of growing the number of stores in an existing fashion chain.
One example is Ross Stores: It created an innovative off-price fashion retail format in 1982, which led to its IPO in 1985. But it was continuing to roll out this concept by opening more stores that helped it go from a $1.4 billion company in 1995 to an $11 billion dollar company in 2014. (It’s why CEO Michael Balmuth is the no. 1 in our fashion retail sample.) It was a similar story with Zara. Its key innovation was from the 1980s: a fast-fashion design, production, and replenishment process that brought more new merchandise into stores, faster. But what made the company’s performance soar under CEO Pablo Alvarez de Tejera was its rapid global expansion between 2005 and 2015.
Of course, there are other ways, aside from store expansion, to sustain high returns in fashion retail, such as global sourcing, growing e-commerce, improving stock management etc. Specialist background is arguably not so important for pulling some of these levers—any good analytically oriented general manager, with some level of retail industry expertise, can find ways to add value.
But there are also top performers who did have specialist background working in fashion design and merchandising—and one could say this was key to their success. For example, Burberry CEO Angela Ahrendts studied fashion design and merchandising and gained deep experience working in these functions at Donna Karan and Liz Claiborne. After inheriting a struggling brand at Burberry, she quickly created a single global design team, focused the product range, and introduced faster merchandising processes. The changes she made did not necessarily lead to breakthrough innovation (the core of the brand is still the trench coat, which was first designed for the British War Office in 1901), but she was able to revitalize the Burberry brand quickly. This is important because when you reposition a fashion offer, there is little room for testing and learning before you commit. Extensive prior experience in fashion design and merchandising help ensure more successful bet.
While the value of having a CEO with specialist experience deserves more research, we find that to drive innovation, CEO experience in product development is important. But a little innovation goes a surprisingly long way. In the pharma industry, the patent-based business model makes breakthrough innovation critical for achieving high returns. We found evidence that CEOs with the relevant technical education and career backgrounds were more likely to oversee breakthrough R&D. However, only about 28% of pharma CEOs have such a background. To us, this seems odd, but it may help explain why the largest pharmaceutical companies – those least likely to have CEOs with technical experience and most likely to have problems with R&D productivity – are outsourcing more R&D to small VC-backed firms, whose managers do have the expertise to lead the search for new drugs.
In high-tech and fashion retail, more CEOs have a product development background than in pharma (around 60% in both industries), but we found that breakthrough innovation for public companies in these industries is rare; most happen pre-IPO. Instead, public companies are mostly exploiting and improving upon past breakthroughs, not coming up with new ones. In this context, CEOs with technical backgrounds don’t necessarily achieve higher shareholder returns than those without. But with rapidly changing technologies and consumer preferences, having the right specialist experience can help CEOs keep their companies and their offerings relevant.