Human Capital Briefs

How Microsoft Avoided the Peter Principle with Nadella

March 28, 2014

In one of the most widely scrutinized CEO successions ever, Microsoft directors selected insider Satya Nadella to run the company, only their third CEO pick in the firm’s nearly 40-year history.  His challenges will be enormous. For starters, he will be running a $75 billion+ enterprise with some 100,000 employees, an army of software engineers and many moving parts. For finishers, he will have to change its treads—redirect its strategy—while barreling down a highway with no map for what lies ahead.

Microsoft’s board had considered a revolving roster of candidates over the past several months, from Nokia’s former CEO Stephen Elop (now back at Microsoft) to Ford’s CEO Alan Mulally. In betting on 22-year Microsoft veteran Nadella, the board has wagered the house: Right pick, Microsoft stays competitive with the likes of Apple, Google, and Oracle; Wrong pick, Microsoft is stuck in 2nd gear, or worse.

The vital—though not-soon-to-be answered—question is whether Mr. Nadella brings the right leadership talents not only to run the show but also to grow the enterprise at the center of one of most turbulent and competitive frays on earth.  And that question is likely to be answered in the affirmative if the directors have managed to avoid the Peter Principle.

Those who have been around a bit will remember a book of that name by Laurence J. Peter.  He argued with plenty of supporting material that sometimes companies, having promoted executives to what they were really good at, elevate them one time too many. Great at mid-level, the managers were not game-ready for the next level.

Moreover, reaching the ultimate level of chief executive is not just another move up the corporate ladder. It is a “jump shift,” as Procter & Gamble chairman A.G. Lafley has described it. Prior jobs cannot totally prepare one for the elevated reality, especially when it now requires running the whole show. The stakes rise exponentially when the final level is the corner office because, unlike lesser destinations, the entire enterprise can be put at risk with the wrong choice.

Fortunately, history is not destiny, and that is no doubt why the Microsoft board, under the guidance of lead director John Thompson, devoted so many months to vetting their twenty-some finalists. And what was critical here, in our view, or at any major enterprise for that matter, is for the directors to take the time to watch the candidates in action and to drill down with bottoms up data. An apples-to-apples comparison of the finalists can be vital as well.

Consider the CEO succession process at pharmaceutical giant GlaxoSmithKline beginning in 2004 when chief executive Jean-Pierre Garnier said he would be exiting in three years. That gave the directors plenty of time, and with that luxury, they methodically narrowed the field to three strong successors, all on the inside. During the final year, they added three paths to gather a last round of data:

1) The CEO and directors assigned a year-long CEO-level project to each of the three finalists. The projects all touched on areas of great strategic concern to the company, and the directors required each of the candidates to report their appraisals and plans to the board.

2) The CEO and directors conducted a “450-degree” assessment of each of the candidates, an expansion of the traditional “360” to include an extra “90” degrees:  They asked fourteen executives who had worked with all three finalists to privately compare their strengths for the top job at hand.

3) They arranged for a one-on-one lunch or dinner for each of the three candidates with each of the company’s sixteen directors.

No one piece of evidence yielded a killer conclusion, but the three sources taken together led to the appointment of dark-horse candidate Andrew Witty as the next CEO.  Even the sitting CEO who knew the three finalists as well as anybody was surprised.

By way of underscoring the power of the bottom-up appraisal, America’s special forces have utilized a similar method in selecting those who will join the nation’s most elite missions. Gathering appraisals from other special-forces personnel on the final candidates—from fellow service members who have seen the finalists on the ground or even in combat—has proven a telling source.

Or consider managed-health care provider Humana’s decision in 2013 to recruit an outsider as its next chief executive. William J. McDonald, who chaired the board’s committee that led the succession process, explained why it had gone to the outside. “I think one of the biggest mistakes boards make is to assess people only in the context of their current jobs.” Becoming a CEO is a far more expansive and demanding job, and he and his fellow directors worried whether the inside talent was then ready for the catapult upward.  “People can change dramatically when they get the brass ring,” he warned.

Most CEO candidates for large companies—like Satya Nadella at Microsoft—emerge from within, and that by definition can give the board the time it needs to vet the candidates in these several ways. But even if insiders are not yet ready, Humana’s McDonald explained that succession is all about “lead time, lead time, lead time.”

Plenty of time also gives the CEO and directors an opportunity to ensure that the eventual insider finalists are given a chance to master the additional skills required for moving up, for transcending any Peter Principle limitations.

Here learn-by-doing can be essential, especially in acquiring an experience-informed ability to work with the directors, investors, analysts, and reporters.  And that extends as well to rounding out the candidates’ personal familiarity with a firm’s far-flung geography and its many technical functions.  Mentoring by the CEO and lead director can be vital here, as can service on another board or two.  When George Buckley served as CEO for innovative manufacturer 3M, he actively encouraged rising stars at the company to serve on outside boards, join quarterly analyst calls, and work directly with the media.

Finally, we appreciate from the experience of many firms that CEO succession should focus on candidates who are top-ranked not only for past performance but also for future challenges. Making that “strategic fit” was surely a factor in Microsoft’s selection of Mr. Nadella, who evidently brings a special appreciation for cloud computing and mobile devices, a new world that the next CEO has to face even if his predecessors had belatedly done so.

Microsoft investors, customers, and employees are all hoping that John Thompson and his board got it right, and that they have managed to avoid Peter’s pitfall to select the leadership that Microsoft requires in the years ahead.

 

This blog first appeared on Harvard Business Review on 2/6/2014.

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