To Operate or To Dominate: How to Incentivize Leaders for Business Model Innovation
For enterprise innovation to succeed, executives need to understand how to align incentives with goals.
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Traditional enterprises have been playing defense for the past decade. In media and hospitality, mergers and consolidation of supply are a tell-tale defensive move. In retail, incumbents are selling off business units or going out of business entirely. The reason for all of these industry upheavals traces back to the same source: the dominance of platform business models.
I co-authored the book Modern Monopolies, and we named it that because platforms are fundamentally restructuring the power dynamics in just about every industry throughout the first half of the 21st century. Fortunately, consumers benefit, for the most part, from these new monopolies unlike old, linear monopolies such as Standard Oil or Ma Bell. Unfortunately, traditional enterprises haven't figured out how to adapt or embrace this new business model. The existing incentive structures around executive compensation are a big factor as to why.
Incentivizing the Long Game
The median tenure of a public company CEO is about five years. A platform business takes seven to ten years to achieve scale, if not closer to twelve years. Unless you are acquiring an existing platform, like Walmart did with Jet.com, there is a misalignment in tenure and therefore compensation for a public company CEO. When your performance and compensation is judged on quarterly returns, why sacrifice your time and short-term returns for a long-term, risky new business model?
True disruptive innovation at a large enterprise starts at the top with the CEO and Board of Directors. If the Board and CEO don't have a vision for the future and can prioritize long term over short term when faced with platform disruption, then the organization will never successfully innovate.
The question here is: should we consider compensating non-founder CEO's differently for driving long-term, disruptive innovation?
According to Bloomberg, median all-in compensation for CEO's in the S&P 500 is about $14 million. This is a lot of money. However, let's put this in perspective: if a CEO can turn his/her company into a modern monopoly, the company will probably have at least 10x'd in market value. A platform business at scale dominates an industry and receives much higher multiples than older, linear business models.
So, said another way, if a CEO can successfully put his/her company on a path to 10x over a 10-year period of time, is it wrong if that CEO is worth a billion dollars? Similarly to a founder of a startup like Jeff Bezos, Larry Page or Sergey Brin, this CEO would have created something new from scratch. The new platform business would not be a true startup, as it could leverage assets and brand value from the core business. But creating any new platform business is extremely difficult, and it's even more difficult to achieve the success of a modern monopoly.
This is why startup founders receive equity. Similarly to how boards could think about incentivizing CEO's and startup employees with equity in new, platform business entities. It's a tried and true model for startups. And, it's not so different than what many legacy enterprises need to do in the platform economy.
Compensating for Platform Innovation
No innovation initiative will be successful if you don't align incentives with goals. A new platform business can be disruptive to your core business, or at a minimum, it will certainly require a very different mindset from a dedicated team.
That's why the first step to embark down the path of business model innovation is to create a new business separate from your core business. There are three groups of people that need to be compensated in order for the platform to successfully grow: A) executive leadership at the core business, B) core business employees that the platform can benefit from (like salespeople) and C) the platform's employees.
Groups A and C are most likely to be motivated by stock, rather than cash, in aligning their incentives with the long-term success of the platform. However, stock is useless unless the platform has a cap table, professional investors, a valuation and, ultimately, an exit event.
Group B will want to feel the upward trajectory for them in joining this new initiative. Joining a new business unit is always a risk. Feeling a sense of ownership and accountability for the success of your platform innovation initiative is key. But the most important aspect is that they understand how the new initiative fits into the core business long term and sets them up for future success.
Finally, it can be very helpful to get an external investor for your platform innovation initiatives. Enterprises have struggled with letting third-party investors into their spin-out ventures. Silicon Valley would say that most corporate startups are more fluff than substance and would therefore never want to get involved. However, working with a strong VC as a partner will make it much easier to attract and retain talent. The external validation will signal to your employees that your platform initiative is around for the long haul, and it will demonstrate that the business is capable of becoming self-sustaining outside of the initial support it receives from the core business.
Platform innovation isn't easy, but the rewards are well worth it. Starting off with the right organizational structure and incentives can be the difference between success and yet another stalled corporate innovation initiative.