How to Make the Forbes List of 100 Most Innovative Companies

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This time every year, Forbes puts out its list of the 100 Most Innovative Companies. It always features a remarkable group. But, like any list, the ranking is simply a result and does not reveal the cause. It is the how-to that is the more interesting educational question.

Before providing an answer, it is important to know that Forbes uses objective criteria to come up with the list. It is not simply a popularity contest. Partnering with Hal Gregersen of MIT and Jeff Dyer of BYU, they calculate an innovation premium for companies across the broad market. This premium is the difference between the net present value of cash flows the company generates (using Credit Suisse’s proprietary HOLT algorithm) and the company’s market capitalization. The implication of this premium is that it is derived from innovation and the market expects that the company will continue to find profitable growth.

3 Qualities of the World’s Most Innovative Companies

So what do the leaders of the most innovative companies in the world have in common? They think and act differently - in three distinct ways: how they allocate capital, how they hire, evaluate, and reward people, and how they ask questions. And like any leadership activity, it can be broken down and taught.

1. Allocate capital differently

Warren Buffett has shared that very few CEOs come prepared for the critical task of allocating capital. Most business schools do not even teach it. Instead, while CEOs need to do two things to be successful—run their operations efficiently and deploy the cash generated by those operations—the majority only focuses on the first. Most CEOs rise through the ranks by managing operations with little focus on capital allocation. But, companies have five essential choices for deploying capital—investing in existing operations, acquiring other businesses, issuing dividends, paying down debt, or repurchasing stock—and three alternatives for raising it—tapping internal cash flow, issuing debt, or raising equity. While these are the plays in their playbook, few CEOs have seriously ever had to run more than a couple of these plays, and typically, the decision was delegated. Over the long term, returns for shareholders are largely determined by the decisions a CEO makes in choosing which of these plays to run. Stated simply, two companies with identical operating results and different approaches to allocating capital will derive two very different long-term outcomes for shareholders. Essentially, capital allocation is investment, and as a result, all CEOs are both capital allocators and investors.

2. Hire, evaluate, and reward people differently

Each year, Google receives more than two million job applications from around the world and hires several thousand of those candidates. It takes an average of six weeks to secure a new hire, and every candidate needs to be screened by their potential boss, potential colleagues, and a hiring committee. What does Google do differently? They set an uncompromising high standard, find candidates on their own, evaluate how objective of thinkers they are, and then provide the candidate a reason to join.

Evaluation of employees in innovative companies is principles-based with a focus on collaboration, teamwork, self-direction, and reflection. Feedback is frequent, and none of these companies uses an antiquated annual review. In many areas, such as business, sports, and academia, research is showing that talent distributions follow a power-law relationship, not a traditional bell-shaped curve. As a result, these companies recognize that it is a fool’s errand to identify and quantify shades of differential performance among the majority of employees.

The leaders of the Forbes 100 list shirk conventional thinking when it comes to compensation. Given employee performance follows a Pareto distribution, the majority of employees receive a competitive base salary and bonuses that are pegged to overall company performance. Special rewards go to truly outstanding performers (the tech sector has become famous for “10x coders get 10x pay”).

3. Think and ask questions differently

Independent thinking is one of the most claimed virtues of boards of directors and CEOs, but few actually practice it. So what is independent thinking? It is consistently applying a rational, analytical approach to decisions large and small. The focus is on empirical data and avoiding crowd thinking. Easier said than done. Peter Drucker said, “The important and difficult job is never to find the right answers, it is to find the right question.” Most CEOs ask ‘what if’ questions such as: What if we change our strategy? What if we bought company X in an adjacent market? What if an activist investor takes a position in our company? All are reasonable questions and the kind that have kept leaders awake at night for ages. But the most innovative companies ask why and why not questions. These questions drive inquiry and analysis in very different directions.

Much of what it takes to make the Forbes List of 100 Most Innovative Companies requires leaders to make creative, sometimes counter-intuitive, decisions. Thinking and acting differently is a good place to start.

 

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Written by Bob Daugherty, Executive Dean in the Forbes School of Business & Technology™

Bob’s article originally appeared on LinkedIn Pulse.

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