June 2012

Governance Perspectives

Pay Attention to the “Blind Spots”

Auditing organizational foresight is a new challenge for internal audit.

Estelle Metayer

Since 2008, many U.S. reform initiatives have focused on reinforcing oversight mechanisms: setting up board-level audit and risk committees, seeking board members with a financial profile or strong operational experience, reinforcing control over compensation, and so on. Regulators and the public assume this is the best way to protect our companies and the economy. Yet, increasing oversight is not the only answer. Effective corporate governance must go deeper to uncover the causes of endemic problems. The recent failures of U.S. firms such as Kodak, Hewlett-Packard, Research in Motion (RIM), and others all come back to the same question: How did such sophisticated companies, with their dedicated executives and many consultants, so dramatically miss the boat? How did they miss technological disruptions (e.g., Kodak), underestimate competitors (e.g., Microsoft and Yahoo), or fail to adapt their business models to changing times (e.g., the media and newspaper industry at large)?

Today, there is an urgent need for boards of directors and management to dedicate more time to “strategic foresight.” They need a different approach to developing the company’s strategy and managing its achievement to ensure they are not missing the types of “blind spots” that led to the recent failures. Internal auditors can help make sure this happens.

One of the hardest habits to develop in learning to drive a car is to watch your blind spots — the area along the periphery of the car where you cannot see other cars. If you don’t consider the blind spot and fail to “shoulder check” when changing lanes or turning, you put yourself and your car in jeopardy.

Blind spots are an apt metaphor for the many kinds of errors and misjudgments that company executives can make. No matter how experienced, intelligent, and well-educated, management is not immune to blind spots in its decision-making.

Blind spots in business are due to three main factors: first, competitive biases, a view of the industry that is too limiting and underestimates competitors; second, corporate biases, where management’s experience and thinking are too homogeneous, with unwavering assumptions that are no longer questioned or taboos that are firmly entrenched; and third, cognitive biases, failures in judgment due to erroneous assumptions and thinking. These three blind spots challenge internal audit executives. Although it is generally recognized that their role includes preparing the company for the long-term, some of the new processes and the mind-set that needs to be ingrained in boards and management likely will add a new dimension of risk for the internal auditor to consider, including risks around ambiguity, clashing goals and objectives, and lost opportunities.

Ambiguity

The only way to be innovative for the long term will be for companies to lock in new business models, making it difficult for competitors to match their products or services. For instance, I can imagine a day when Nike would not sell its running shoes but instead a subscription to the use of a running shoe. The company would ship new models automatically to its customers based on the amount of miles run and the terrain they cover (which Nike could track via GPS). Yet, auditors are often wary of new business models and revenue/cost projections based on such grand visions. When Nestle started its Nespresso product, the company lost money for 15 years before it became a success. Most companies would have killed the project before waiting for that time.

Clashing Long-term Goals and Short-term Objectives

As companies strive to be more sustainable, some long-term goals will contradict short-term measures. For example, a garbage collection company might damage its existing business (encourage its clients to recycle more to reduce waste) to create a future one.

Lost Opportunities

The greatest danger in blind spots is not what a company might overlook (like Kodak missing out on the technology shift to digital), but missed opportunities. For example, RIM is focusing on launching new technology for corporate executives (new tablets in response to the iPad). But it is missing the bigger market. Its biggest fans are Generation Y who rave about the BlackBerry Messenger (free short messaging service) technology. Yet none of RIM’s advertising targets this segment, leading us to believe the company is failing to lock up that generation and guarantee a solid future customer base.

As industries move from complex (many known variables that interact) to chaotic (multiple unknown scenarios that could develop from any one set of factors), the auditor’s checklists and toolkit need to change. There are several critical questions that auditors must address.

At the board level:

  • Does the board of directors include a technology committee?
  • Is there a strategic committee? If so, does the chief audit executive attend strategic planning committee meetings?
  • How much board time is spent on strategy? How much of that discussion deals with the second and third horizons (more than three-year time frame) versus the current one?
  • How homogeneous is the board of directors? How likely is it that a single logic would develop and dominate alternative thinking about blind spots?
  • When was the last time a board member spoke to a client/customer? What is the risk of false consensus developing (i.e., the tendency for people to overestimate the degree to which others agree with them)?

In the executive suite:

  • How much time is dedicated to in-depth strategic discussions and dialogue (not counting any time spent reviewing PowerPoint presentations). Steve Jobs at Apple allegedly spent every Monday morning with his executive team solely discussing future products and the company’s growth. I have never seen any other company dedicate that amount of time to the future, and we know how future thinking paid off for Apple.
  • Is there a structured competitive intelligence process?
  • What future time frame is considered in strategy discussions?
  • Does the company incorporate in its competitive scanning nontraditional competitors (i.e., companies that are not yet competing in the same arena but could)?
  • Are senior leaders exploring different business models? What is the process they use to prototype those models? What are their assumptions?
  • How homogeneous is the management team? Is there a healthy ability to dissent?
  • What is done to diversify the company’s frame of reference?
  • What is on the list of unchallenged assumptions?
  • How much do projections rely on past performance? Is there a reason to trust past trends?
  • Is the company revisiting past failures when market conditions change?

Internal audit has an opportunity to increase its relevance, but the profession must: 1) improve auditor understanding of strategic planning (for example by offering strategic audit courses in training curriculum); 2) develop new tools to assess whether blind spots are understood and addressed by the board and management; and 3) create a shared knowledge base of corporate failures due to strategic failures, including lessons learned and how auditors could have made a difference. This would provide internal audit the opportunity to get involved at a more strategic level, establishing its credibility as a relevant — and significant — discussion partner on these issues with both the board and the executive team.

Estelle Metayer, principal and founder of Ottawa, Ontario-based Competia, advises boards and executives in strategic governance.


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