Managing performance through famine and feast. The CFO’s role as “economic advisor”
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2 Noiembrie 2011 |
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ERNST & YOUNG S.R.L. |
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Dealing with economic challenges
The credit crunch and subsequent recession left many organizations in a state of turmoil. As a consequence, the Finance functions of businesses in affected sectors have focused sharply on reducing costs in an attempt to protect profits in the face of stagnating or falling revenues.
However, without a clear understanding of the drivers of cost, many CFOs have found it difficult to ascertain where and how to make savings beyond the most obvious discretionary spend items. Furthermore, some of the resultant cost cutting may have alleviated the short-term pressures, but it may have had a damaging impact on the company’s underlying capabilities. These are the exact same capabilities that will be required to take advantage of any resurgence in economic conditions in order to restart revenue growth.
This type of cost reduction can be characterized as “crash dieting.” Dieters understand the difficulty of sustainability — if you opt for quick and drastic changes, you may see fast results; but the real challenge is to maintain the beneficial effects beyond the achievement of immediate, short-term goals.
The problem often stems from businesses having poor understanding of the nature of costs in terms of how they contribute to revenue, and a structural bias toward fixed costs rather than variable ones. Thus, most cost-reduction programs are constrained to focus on making arbitrary quick wins by attacking the more obvious discretionary variable costs.
With the increasing levels of confidence and talk of recovery, businesses are still focused on costs, but they are increasingly showing a level of sophistication that has moved away from the “crash dieting” approach to one that can be characterized as “cost optimization,” something similar to the concept of “lifestyle change” for those crash dieters determined to achieve long-term, sustainable goals.
There are two important lessons to emerge from this:
- Many organizations still do not have the information nor the processes that allow for an informed transparency of the true cost base, or a clear understanding of how costs correlate to value-creating activities within the business. As a result, cost reduction strategies continue to risk being unsustainable and potentially harmful to long-term prospects for growth.
- Despite the global trends in outsourcing and in de-risking supply chains, it has become obvious that many apparently successful businesses have continued to rely on traditional models of maintaining full control over their supply chains and the associated heavy bias toward fixed costs that goes with it. However, leading organizations have proven that switching away from fixed costs to a more variable cost base is an effective way of becoming agile enough to de-risk unpredictability in demand and vulnerability in supply; this transformation requires a change in attitude to business and operating models.
The CFO’s strategic role as “business partner”
Market studies, which include Ernst and Young’s 2010 report The DNA of the CFO*, have consistently shown that delivering commercial insight to the business is the most significant way in which Finance can add value.
For more than a decade, studies and articles have been clearly finding and recommending that CFOs and the Finance function should act more strategically and more commercially, helping to improve performance through delivering insight to business decision-makers. This role has typically been described as “business partnering,” with the CFO variously being described as a “catalyst” or “value integrator.”
Ernst & Young’s work with organizations across the globe has taught us that, while this is a commonly held view, successful business partnering is much sought, but rarely achieved.
Failure to understand the role of business partner and build the capabilities to deliver it credibly has meant the benefits expected have not materialized and the credibility of Finance to fulfill the role has been dented. This has been evidenced by the general response to the credit crunch and subsequent recession, where the lack of predictive ability and agile response has demonstrated that most organizations do not have the skills and resources within their Finance functions to manage performance during turbulent economic times. Additionally, Finance too often acts as an “observer” of performance during periods of growth and profitability, so that business results are more likely to be driven by market conditions than Finance’s ability to help decision-makers optimize market opportunities.
What it means to be a “business partner”
So, how can Finance help drive commerciality into the business? Which areas of the business should Finance be concentrating on? What will enable Finance functions to provide better analytics, and become more strategic and commercial in their daily operations?
The specific outcomes and activities underpinning business partnering are poorly defined: they are often described in terms of behavioral traits, coupled with access to better quality information.
In our view, the essence of a CFO as a good business partner is someone who:
- Facilitates transparency of financial performance across their organization and works with commercial leaders to drive improved performance
- Ensures business decisions are grounded in sound financial analysis, enabled by processes that drive robust financial challenge and accountability
- Supports senior managers in strategy decisions by providing analysis and insight that prioritizes the allocation of scarce resources to areas of the business where the greatest value will be generated
- Manages the Finance function in operating from an efficient base, allowing the brightest and most talented resources to focus on value-adding analysis to support strategic and commercial operations
By reviewing the fundamentals of performance management and what business partnering should mean, we have identified the specific activities that Finance needs to concentrate on to fulfil the obligation. In doing this, we have determined that the heart of business partnering rests in practical economic theory and the effective allocation of scarce resources to achieve financial objectives.
