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Laurence  Lock  Lee  /  Cai  Kjaer  

31  August  2012  

CONNECTEDNESS  DRIVES  

PERFORMANCE  -­‐  A  study  into  organizational  connectivity  and  diversity.  The  cry  for  diversification  on  boards  is  loud  and  clear.  But  how  much  diversification  is  enough?  As  with  any  diversification  strategy,  too  much  can  actually  damage  performance.  How  can  Boards  identify  the  ‘right’  balance  to  optimise  financial  performance?  Is  a  gender  quota  really  the  answer?  The  diversification  argument  doesn’t  stop  at  the  front  door.  What  is  the  right  balance  of  diverse  experiences  and  specialisation  for  our  future  leaders?  What  is  the  right  balance  between  disruptive  and  incremental  innovation?  How  flat  should  our  organisational  structure  be?  These  are  questions  that  all  senior  executives  face  at  some  time  or  other.  What  is  lacking  is  specific  guidance  with  some  quantitative  measures,  linked  to  bottom  line  outcomes.  

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WHITE-­‐PAPER:  CONNECTEDNESS  DRIVES  PERFORMANCE  -­‐  A  study  into  organisational  connectivity  and  diversity  The  cry  for  diversification  on  boards  is  loud  and  clear.  But  how  much  diversification  is  enough?  As  with  any  diversification  strategy,  too  much  can  actually  damage  performance.  How  can  Boards  identify  the  ‘right’  balance  to  optimise  financial  performance?  Is  a  gender  quota  really  the  answer?  

The  diversification  argument  doesn’t  stop  at  the  front  door.  What  is  the  right  balance  of  diverse  experiences  and  specialisation  for  our  future  leaders?  What  is  the  right  balance  between  disruptive  and  incremental  innovation?  How  flat  should  our  organisational  structure  be?  These  are  questions  that  all  senior  executives  face  at  some  time  or  other.  What  is  lacking  is  specific  guidance  with  some  quantitative  measures,  linked  to  bottom  line  outcomes.  

How  powerful  would  it  be  to  have  a  quantitative  measure  for  diversity  that  is  clearly  linked  to  your  bottom  line  performance?  

The  following  diagram  provides  a  ‘birds  eye  view’  of  how  ASX  boards  are  connected  through  shared  board  memberships:  

 

The  above  diagram  clusters  the  interconnections  by  industry  sector.  The  nodes  represent  listed  companies  and  are  sized  by  the  number  of  connections  that  they  have.  One  can  see  that  there  are  centrally  connected  firms  in  nearly  all  sectors.    

Taking  a  closer  look  at  a  particular  example  using  the  Optimice’s  Company  Mapper  tool1,  one  can  see  which  particular  directors  are  providing  connections  to  other  firms.  It  is  these  directors  that  have  the  potential  to  provide  the  diversity  of  thought  and  experience  as  garnered  from  their  other  board  memberships.    

                                                                                                                                       1  See  http://www.optimice.com.au/companymapper  

 

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In  this  paper  we  identify  the  extent  to  which  board  connections  with  other  companies  i.e.  shared  directorships,  potentially  contribute  to  bottom  line  performance.  We  have  found  that  there  is  a  ‘sweet  spot’  beyond  which  additional  connections  can  actually  harm  performance.  

Our  sample  is  the  583  listed  firms  from  the  ASX  (Australian  Stock  Exchange)  who  have  reported  revenue  and  market  capitalisation  results  for  the  period  2004-­‐2012.  We  studied  these  companies  to  identify  the  company  ‘connectedness’  by  measuring  the  number  of  other  companies  they  are  interconnected  with  via  a  shared  board  member.    

The  number  of  connections  ranged  from  zero  to  18.  We  hypothesised  that  connections  were  good,  as  they  provided  the  potential  for  bringing  a  diversity  of  opinions  and  experience  to  a  board.  We  also  speculated  that  having  too  many  connections  might  cause  boards  to  lose  focus  and  become  distracted  by  the  pure  breadth  of  diversity  being  brought  to  the  table.    

We  plotted  the  number  of  company  connections  against  the  %  CAGR  in  revenue.  While  we  found  a  modest  linear  relationship  favouring  more  connections,  the  enduring  pattern  came  when  we  investigated  the  non-­‐linear  patterns.  A  quadratic  curve  fit  identified  a  clear  ‘sweet  spot’  where  %CAGR  was  optimal,  and  that  occurred  in  the  range  between  7  and  9  connections.    

The  83  companies  in  this  sweet  spot  achieved  an  average  15%  CAGR  in  revenue  as  opposed  to  the  108  firms  who  had  no  connections  and  achieved  on  average  a  4.8%  CAGR  in  revenue.  The  CAGR  in  revenue  dropped  off  for  those  firms  having  more  than  9  connections.    

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The  average  number  of  connections  per  firm  is  4.18,  suggesting  that  a  majority  of  listed  organisations  would  benefit  from  increasing  their  diversity  through  connections  to  other  companies.  Inviting  a  board  member  who  is  well  connected  may  be  a  good  way  of  substantially  increasing  your  growth  rates  into  the  future.  

Connectedness  and  Diversity  Inside  Organisations  One  of  the  luxuries  one  has  in  working  with  stock  market  data  is  that  bottom  line  performance  data  is  readily  available  for  assessing  potential  impacts  of  different  business  characteristics.  Most  executives  however  sit  inside  organisations,  with  very  much  an  internal  focus.  Bottom  line  performance  measures  for  internal  departments  can  be  problematic.  In  many  cases  internal  measures  can  even  lead  to  value  destroying  internal  competition.  Inherently  executives  accept  that  a  diversity  of  experience  is  a  good  thing.  But  there  is  no  ruler  calibrated  for  diversity.  How  much  is  enough?  What  is  an  appropriate  investment  in  diversity?  Is  there  a  magic  number?  

Professor  Ron  Burt  from  the  University  of  Chicago  has  spent  a  career  analysing  the  contribution  ‘bridges  and  brokers’  play  in  business.  Overlapping  board  memberships  are  an  example  of  a  broker  or  bridge  role.  Framed  in  the  context  of  ‘social  capital’,  Burt  has  quantified  correlations  between  leaders  identified  as  brokers  being  promoted  faster,  being  paid  more  and  having  their  ideas  more  readily  accepted.  

 However,  Burt  also  acknowledges  that  those  that  are  central  to  a  closed  network  i.e.  our  acknowledged  ‘specialists’,  provide  a  complementary  source  of  value2.  Specialists  gain  their  reputation  from  being  acknowledged  by  their  peers  in  what  is  often  a  dense  and  exclusive  network.    Overall  organisational  value  is  therefore  gained  by  achieving  a  balance  between  diversity  and  specialisation.  So  can  we  identify  the  balance  point  by  extrapolating  our  findings  from  this  study  into  internal  company  connectedness?  

The  average  number  of  board  members  from  our  selected  sample  is  7.  We  found  that  on  average  these  7  directors  provided  4.18  connections  to  other  companies  or  just  under  0.6  

                                                                                                                                       2  Burt,  R.S.  (2005),  “Brokerage&  Closure”,  Oxford  University  Press  

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connections  per  director.  Our  ‘sweet  spot’  indicated  a  range  of  7  to  9  connections  being  optimal.  To  achieve  this  we  need  to  either  improve  the  number  of  connections  provided  per  director  to  over  1  per  director.  Alternatively  we  can  raise  the  number  of  board  members  to  a  level  that  can  naturally  achieve  our  ‘sweet  spot”.  The  optimum  board  size  based  on  a  0.6  connection/director  would  therefore  be  between  12  and  15,  to  achieve  an  adequate  level  of  diversity.  

Is  this  also  the  answer  for  internal  senior  management  teams?  This  number  may  appear  to  be  a  little  excessive,  but  not  uncommon  for  internal  management  teams.  This  could  be  reduced  if  the  members’  diversity  performance  can  be  raised  i.e.  on  average  the  senior  management  team  can  demonstrate  an  ability  to  represent  at  least  one  other  internal  department  or  function,  other  than  their  own.  Lets  see  how  this  may  play  out  in  a  practical  sense:  

 

In  conducting  a  standard  organisational  network  analysis,  we  survey  respondents  asking  them  to  nominate  people  that  they  critically  depend  on  to  get  their  work  done.  We  also  ask  them  to  nominate  which  business  unit  they  belong  to.  One  of  the  outputs  from  this  data  is  what  we  call  our  “Demand”  chart,  identifying  the  nature  of  the  dependencies  within  and  between  business  units.  

The  chart  plots  the  nominations  that  an  individual  receives  against  the  %  of  those  nominations  that  come  from  outside  their  own  business  unit.  The  quadrants  are  designed  to  depict  where  individuals  are  placed  in  the  organisation’s  dependency  network.  Those  on  the  right  hand  side  of  the  chart  are  ‘in  demand’  staff,  divided  into  ‘specialists’,  who  are  mostly  nominated  by  those  inside  their  own  business  area,  and  the  ‘ambassadors’  who  are  largely  nominated  by  those  from  outside  their  own  business  unit.  It  is  not  uncommon  to  see  the  senior  management  occupy  the  ambassador  positions,  or  indeed  high  potential  staff  may  also  be  seen  in  this  quartile.    

On  the  left  hand  side  are  the  less  in  demand  staff,  divided  into  the  ‘practitioners’,  who  are  mainly  nominated  from  within  their  own  business  area,  and  the  ‘agents’  who  tend  to  be  nominated  from  outside  their  own  business  units.  Typically  we  will  see  the  practitioner  quartile  being  the  most  populated.  The  agent  quartile  may  typically  contain  internal  service  line  staff.  

In  terms  of  diversity,  the  question  is  how  many  ‘ambassadors’  should  we  be  looking  to  develop?  What  is  the  right  balance  to  between  having  a  cohesive  network  of  internally  focused  staff  and  the  diverse  external  contacts  required  for  maximum  performance?  Firstly  we  want  to  get  as  many  as  possible  on  the  right  hand  side  of  the  demand  matrix.  A  heavily  populated  right  hand  

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side  means  more  cohesive  networks.  From  the  connectedness  study,  the  magic  number  is  7  to  9  interlocks,  which  at  current  rates  of  connectivity  maps  to  an  optimum  board  size  of  12  to  15.  Now  this  isn’t  to  suggest  that  the  load  should  be  evenly  spread,  but  we  would  suggest,  based  on  a  previous  study3,  that  diversity  should  be  contributed  by  at  least  2  of  that  12  to  15,  or  roughly  between  13%  –  17%.  So  here  is  our  ‘rule  of  thumb’  for  diversity:    

“For  optimal  performance,  organisations  should  aim  to  allocate  15%  of  their  resources  to  diverse  non-­‐core  activities”.  

We  could  also  suggest  that  organisations  should  aim  to  have  15%  of  staff  in  the  ‘Ambassador”  quadrant,  15%  of  the  innovation  investments  directed  to  ‘breakthrough’  ideas,  15%  of  staff  time  free  to  develop  their  own  ideas  for  the  business,  15%  of  management  teams  drawn  from  minorities…the  list  could  go  on.  

Some  Closing  Thoughts  We  started  this  paper  with  some  very  compelling  evidence  that  a  specific  optimal  measure  of  connectedness,  introduced  through  overlapping  board  memberships,  can  be  determined  where  company  growth  is  maximised.  That  number  is  between  7  and  9  board  connections.  Organisations  with  that  number  of  company  connections  delivered  on  average  15%  CAGR  in  revenue  over  a  9  year  period,  in  contrast  to  4.8%  CAGR  delivered  by  companies  with  no  connections.  We  then  took  these  findings  and  extrapolated  them  to  how  they  may  be  interpreted  to  provide  internal  guidance  on  diversity.  We  came  up  with  the  magic  number  of  15%.  While  the  science  becomes  more  dubious  with  each  extrapolated  step,  in  the  absence  of  a  better  number  we  offer  this  number  to  guide  your  diversity  efforts.  

 

 

About  Optimice    Optimice  provides  specialised  consulting  services  and  tool  to  help  organisations  map  and  improve  business  relationships.  Optimice  identifies  relationship  patterns  between  people,  organisations  or  markets,  and  we  have  improved  the  basic  techniques  to  optimise  these  relationships  in  a  compelling  business-­‐focused  context.    

 Optimice  Pty  Ltd  Level  6,  20  Loftus  Street  Circular  Quay  Sydney  NSW  2000  Phone:  02  8002  0035  www.optimice.com.au  

About  Hargraves    The  key  to  the  Hargraves  Institute  is  ‘Collective  Wisdom’,  shared  amongst  the  members  through  the  art  of  trusted  conversations.  Collective  wisdom  comes  from  the  interactions  of  our  diverse  network  and  members  and  the  solutions  are  created  in  the  body  of  knowledge  developed  by  these  talented  people.  

 Hargraves  Institute  Pty  Ltd  Suite  402,  12  Century  Circuit,  Norwest  Business  Park  Baulkham  Hills    NSW    2153  Phone:  02  9954  5483  www.hargraves.com.au  

 

                                                                                                                                       3  In  our  study  on  “Networked  Board  Members”  we  found  higher  financial  performance  is  associated  with  dual  board  members  interlocks.