June 22, 2023

TPL Insights #176 – Mindsets, Practices, and a Model for CEO Excellence

By Rob Andrews

 

By Rob Andrews with content from the McKinsey & Company article titled “The mindsets and practices of excellent CEOs” published on October 25, 2019

According to McKinsey research, CEOs who insist on rigorously measuring and managing all cultural elements that determine organizational health and drive performance more than double the odds that their strategies will be executed. And over the long term, they deliver triple the total return to shareholders that other companies deliver. This piece summarizes McKinsey’s take on CEO excellence.

Barely three out of five new CEOs meet performance expectations in their first 18 months on the job. The standards set by boards directors, shareholders, customers, and employees create an environment of endless scrutiny in which a new CEO can either make or break their entire career. While much is expected of a new CEO, little is understood about specifically how a new one can navigate these choppy waters effectively.

McKinsey’s Marvin Bower considers the job so specialized that the only way to prepare for it is to hold the post. Most of the CEOs he’s interviewed hold similar views, saying that even asking other successful CEOs for their views doesn’t help, because suggestions vary widely once they go beyond high-level advice like set the vision and strategy, shape the culture, and put the right people in the right seats. Bower’s research indicates that fellow CEOs don’t necessarily make reliable guides.

Academic and other research on the CEO’s role hasn’t done much either to illuminate how great CEOs think and what they do to excel. Recent studies of how CEOs spend their time don’t show the difference between a good one and a bad one. Academic research does show that drive, resilience and risk tolerance are important attributes for CEOs, but while that insight might be useful during a search for a CEO, it does little to assist a new or sitting CEO to improve his or her performance. This article summarizes performance data on thousands of CEOs and highlights which mindsets and practices are proven to make CEOs most effective.

A Model for CEO Excellence

To answer the question, “What are the mindsets and practices of excellent CEOs?” McKinsey started with the six main elements of the CEO’s job—elements touched on in virtually all literature about the role: setting the strategy, aligning the organization, leading the top team, working with the board, being the face of the company to external stakeholders, and managing one’s own time and energy. They then broke those down into 18 specific responsibilities that fall exclusively to the CEO. For example, setting a corporate strategy requires that the CEO make the final call on an overall vision, a set of strategic moves, and the allocation of capital.

Focusing on those 18 responsibilities, they conducted extensive research to determine what mindsets and practices distinguish excellent CEOs. They mined their database on CEO performance, which is the largest of its kind, containing 25 years’ worth of data on 7,800 CEOs from 3,500 public companies across 70 countries and 24 industries. They also drew on what they’ve learned from helping hundreds of CEOs to excel, from preparing for the job and transitioning into it, through navigating difficult decisions and moments of truth, to handing responsibilities over to a successor.

Corporate strategy: Focus on Beating the Odds

It’s incumbent on the leader to set the direction for the company—to have a plan in the face of uncertainty. One way that CEOs try to reduce strategic uncertainty is to focus on options with the firmest business cases. Research shows, however, that this approach delivers another sort of outcome: the dreaded “hockey stick” effect, consisting of a projected dip in next year’s budget, followed by a promise of success, which never occurs. A more realistic approach recognizes that 10 percent of companies create 90 percent of the total economic profit (profit after subtracting the cost of capital), and that only one in 12 companies moves from being an average performer to a top-quintile performer over a ten-year period. The odds of making the jump from average to outstanding might be long, but CEOs can greatly increase the probability of beating those odds by adhering to these practices:

Vision: Reframe what winning means. The CEO is the ultimate decision maker when it comes to setting a company’s vision (where do we want to be in one, five, or 10 years?). Great CEOs do this by considering their mandate and expectations (from the board, investors, employees, and other stakeholders), the relative strengths and purpose of their company, a clear understanding of what enables the business to generate value, opportunities and trends in the marketplace, and their personal aspirations and values. The best go one step further and reframe the reference point for success. For example, instead of a manufacturer aspiring to be number one in the industry, the CEO can broaden the objective to be in the top quartile among all industrials. Such a reframing acknowledges that companies compete for talent, capital, and influence on a bigger stage than their industry. It casts key performance measures such as margin, cash flow, and organizational health in a different light, thereby cutting through the biases and social dynamics that can lead to complacency.

Strategy: Make bold moves early. According to McKinsey research, five bold strategic moves best correlate with success: resource reallocation; programmatic mergers, acquisitions, and divestitures; capital expenditure; productivity improvements; and differentiation improvements (the latter three measured relative to a company’s industry). To move “boldly” is to shift at least 30 percent more than the industry median. Making one or two bold moves more than doubles the likelihood of rising from the middle quintiles of economic profit to the top quintile, and making three or more bold moves makes such a rise six times more likely. Furthermore, CEOs who make these moves earlier in their tenure outperform those who move later, and those who do so multiple times in their tenure avoid an otherwise common decline in performance. Not surprisingly, data also show that externally hired CEOs are more likely to move with boldness and speed than those promoted from within an organization. CEOs who are promoted from internal roles should explicitly ask and answer the question, “What would an outsider do?” as they determine their strategic moves.

Resource allocation: Stay active. Resource reallocation isn’t just a bold strategic move on its own; it’s also an essential enabler of the other strategic moves. Companies that reallocate more than 50 percent of their capital expenditures among business units over ten years create 50 percent more value than companies that reallocate more slowly. The benefit of this approach might seem obvious, yet a third of companies reallocate a mere 1 percent of their capital from year to year. Furthermore, research found that the top decile of high performing CEOs are 35 percent more likely to dynamically reallocate capital than average performers. To ensure that resources are swiftly reallocated to where they will deliver the most value rather than spread thinly across businesses and operations, excellent CEOs institute an ongoing (not annual) stage-gate process. Such a process takes a granular view, makes comparisons using quantitative metrics, prompts when to stop funding and when to continue it, and is backed by the CEO’s personal resolve to continually optimize the company’s allocation of resources.

Organizational alignment: Manage Performance and Health with Equal Rigor

Ask successful investors what they look for in portfolio companies, and many will tell you they’d rather put money on an average strategy in the hands of great talent than on a great strategy in the hands of average talent. The best CEOs put equal rigor and discipline into achieving greatness on both strategy and talent. And when it comes to putting great talent in place, almost half of senior leaders say that their biggest regret is taking too long to move lesser performers out of important roles, or out of the organization altogether. The reasons for this are both practical (good leaders provide the CEO with important leverage) and symbolic (CEOs who tolerate poor performance or bad behavior diminish their own influence). Many CEOs also say they regret leaving adequate performers in key positions and failing to realize the full potential of their roles. The best CEOs think systematically about their people: which roles they play, what they can achieve, and how the company should operate to increase people’s impact.

Talent: Match Talent to Value. Many CEOs have confided they worry about asking the same few overstretched “usual suspects” to take extra assignments because they can’t trust the people who would otherwise perform them. The best CEOs take a methodical approach to matching talent with roles that create the most value. A crucial first step is discovering which roles matter most. Careful analysis typically produces findings that surprise even the savviest CEOs. Of the 50 most value-creating roles in any given organization, only 10 percent normally report to the CEO directly. Sixty percent are two levels below, and 20 percent sit farther down. Most surprising of all is that the remaining 10 percent are roles that don’t even exist. Once these roles are identified, the CEO can work with other executives to see that these roles are managed with increased rigor and are occupied by the right people. Robust talent pipelines can also be developed so that important roles remain well staffed. The best CEOs ensure that their own role is included so that the board has viable, well-prepared internal candidates to consider for succession.

Culture: Go Beyond Employee Engagement. Vendors of workforce surveys like to say that employee engagement is the best measure of “soft stuff.” It’s not. While employee engagement indeed correlates with financial performance, a typical engagement survey covers less than 20 percent of the organizational-health elements that are proven to correlate with value creation. A proper assessment of organizational health takes in everything from alignment on direction and quality of execution to the ability to learn and adapt. In the largest research effort of its kind, McKinsey found that CEOs who insist on rigorously measuring and managing all cultural elements that drive performance more than double the odds that their strategies will be executed. And over the long term, they deliver triple the total return to shareholders that other companies deliver. Doing this well involves thoughtful approaches to role modeling, storytelling, aligning of formal reinforcements (such as incentives), and investing in skill building.

Organizational Design: Combine Speed with Stability. “Agility” is one of most widely used and misunderstood management buzzwords of the past decade. For many leaders, agility evokes speed in decision making and execution, as opposed to the deliberate pace dictated by the stable, standardized routines of large organizations. The facts show that agility requires no such trade-off: on the contrary, companies that are both fast and stable are nearly three times more likely to rank in the top quartile of organizational health than companies that are fast but lack stable operating disciplines. Excellent CEOs increase their companies’ agility by determining which features of their organizational design will be stable and unchanging (such features might include a primary axis of organization, a few signature processes, and shared values) and by creating dynamic elements that adapt quickly to new challenges and opportunities (such elements might include temporary performance cells, flow-to-work staffing models, and minimum-viable-product iterations). A services company CEO, for example, better enabled her “one company” strategy by shifting the profit-and-loss axis from products to geographies, reorganizing the back office according to an agile flow-to-work model, and creating a new agile product development group.

McKinsey’s research confirms our thesis that organizational health and great cultures are far more important than most people realize. Stay tuned for more content around Total Performance Leadership and the nine principles that enable organizations at the top of their sectors to dominate.

Warmest Regards,

Rob