We recently wrote a short article, “Don’t be Road Kill on the Innovation Highway,” for InnovateNow, a foundation launched by the Chicago Chamber of Commerce to “promote ongoing business innovation and regional economic growth and to transform Chicagoland into a global center of innovation, entrepreneurship and creativity.” Here’s a “link to the formatted article,” or you can read it below.

Don’t be Road Kill on the Innovation Highway
Using a Strategy Stress Test to Greatly Increase the Odds of Innovating Successfully

By Chunka Mui and Paul Carroll

History tells us that recessions are times of competitive flux.  The strategic decisions that managers are making today will not only determine who survives the downturn, but also who is best-positioned to lead when the economy kicks into a higher gear.  Now is the time when innovation can yield bountiful fruit. Yet, numerous studies have shown that a majority of big innovation efforts fail: Roughly two out of three corporate acquisitions fail, as measured by the performance of the stock of the acquiring company.  Organic strategies, such as entering adjacent markets or launching new products, have even higher failure rates. What if those odds could be flipped? What if it were possible to succeed two times out of three and just fail a third of the time?

Our research suggests this is possible. A 20-person team that spent two years investigating 2,500 major corporate failures from the past 25 years found that almost half stemmed from ill-conceived strategies that could have been reshaped early, before millions, if not billions, had been lost. Applying the lessons derived from that research can help executives dodge problems and foster innovation in ways that greatly increase the chances of success.

Strategic initiatives usually fail because, in part, decisions have to be made fast when an opportunity arises. Something is for sale. Do you want it? Well, do you? The clock is ticking. (BofA CEO Ken Lewis decided to buy Merrill after less than an hour of negotiating, for fear that he’d be outbid if he didn’t act immediately.)

The other main problem is that strategic decisions are made in an echo chamber. The senior executive team, trying to please the CEO, can censor objections and gloss over problems. Even the best investment bankers and consultants become too optimistic. Boards can spot problems, but directors can be reluctant to speak up because they don’t have as much information as the CEO and seldom have as much background in the industry. In addition, vetoing a strategic initiative is usually a bring-on-the-next-guy decision, so, when in doubt, boards tend to acquiesce. Even Warren Buffett has said that, while on the Coca-Cola board, he failed to challenge the CEO about an issue even though he was quite sure the CEO was making a serious mistake and was right.

To counteract these issues, board members, executives, and investors need a way to get a fast, objective read on the potential problems.

A process that would have headed off a high percentage of the failures we studied is what we call a “strategy stress test.” Informed by the billion-dollar lessons derived through our research, the stress test uses debate, role-playing, scenarios and other analytical tools to bring to the surface not only all the problems that an executive team could already perceive, but also many that can be off everyone’s radar.

The stress test functions in a way that the team can tolerate. It doesn’t make the CEO or anyone else look bad. The panel that conducts the test acts as a trusted, confidential adviser who can, at least, preserve the jobs of the CEO, his subordinates and the board, while perhaps making lots of money for both executives and shareholders.

Our review consists of three parts, as shown in Figure 1:

The first examines the proposed strategy against the lessons of past failures.  We draw on our research to find companies that attempted something similar to what is being contemplated and failed. That way, we can see if the strategy raises any of the red flags that indicated the others were about to flop. This part of the process differs from the norm because the tendency in businesses, as in business books, is to look at success stories and say, “Here’s how we can be like those guys.” We instead look at failures to figure out, “Okay, here’s how we can avoid being like those guys.

The second part consists of a “last-chance” independent review that looks at any red flags, at any questionable assumptions, at all risks, etc.  This review is typically done toward the end of the process but before it’s too late, before the CEO publicly commits himself and before momentum is so great that almost nothing can stop the deal.

The third part consists of working with management and, if appropriate, the board of directors to come to closure.  A frank assessment of critical questions and potential problems drives management’s final deliberations, allowing the executive team to improve the strategy or, in extreme cases, kill the idea before it costs a lot of money.  The team can also change negotiating tactics, if an acquisition is involved.

Given the right perspective and license, even a cursory review can spot all sorts of problems. Look at Bank of America’s $50 billion acquisition of Merrill Lynch. Or look at private-equity fund Bay Harbour Management’s decision to buy the Steve & Barry’s retail clothing chain out of bankruptcy proceedings for $168 million, only to announce three months later that it would liquidate the chain. Based on our research, we identified both those moves as flawed at the time they were announced, but it was too late for BofA and for Bay Harbour. (For more on our thoughts on these and other strategies, scan this  blog.)

Even if you can build more constructive contention into your strategy processes or into your investment analysis, you may still fail. After all, business is a contact sport. Companies win. Companies lose. But if you can catch your obvious mistakes—and our research found that almost half of strategy mistakes were obvious ones—then you’ll be much less likely to fail and that much more likely to succeed.