Why CFOs Need a Bigger Role in Performance Transformations
Without the CFO’s leadership certain key elements of the transformation are likely to receive short shrift: performance efforts will lack a meaningful benchmark to gauge success, managers will be tempted to focus on the biggest or most visible projects instead of those that promise the highest value, and expected transformation benefits won’t make it to the bottom line. That is why when transformations are planned, it’s important that CFOs step up to play a broader role, one that includes modeling of desired mindsets and behaviors in transforming the finance function itself.
Establishing a Clear Financial Baseline
The value of a transformation is only measurable relative to a meaningful baseline, a natural part of the process for the finance function to manage. An effort that improves a company’s earnings by $200 million might appear successful if one didn’t know that the market grew at the same rate. Similarly, a transformation where earnings fell by 5 percent might seem to have failed, if one didn’t know that earnings would have fallen by 20 percent without the effort. And performance can be affected by any number of events and activities unrelated to a transformation underway, such as M&A, openings or closures of plants, fluctuations of commodity prices, and even unplanned business disruptions or large restructuring charges. It sounds like a simple dynamic, but it’s often misunderstood and poorly communicated. Many companies simply use the previous year’s reported financials as a simple baseline. That’s preferable to using forecasts or budgets, which can include suspect assumptions, but a meaningful baseline is usually more complicated. The previous year’s performance might reflect one-time adjustments or may not accurately reflect the momentum of the business—which is the true baseline of performance. CFOs can verify that improvement initiatives aren’t simply cutting investments in tomorrow’s performance to boost today’s numbers. They can also check for noncash improvements that show up on the profit and loss (P&L) statement but don’t actually create value.
Instead, managers would need a baseline that reflected forecasts for how much prices would deteriorate, both overall and by region. This is a natural part of the process for the finance function to own since baselines are necessary for valuing both individual initiatives and overall transformation performance. That said, there is no cookie-cutter formula that applies to every company—and adjusting a baseline often involves a lot of moving parts.
Clarifying which Initiatives Create Value
Given the volume of initiatives and limited time and resources available in a transformation, managers often find it challenging to set priorities for the ones that promise the most impact. Good ideas often languish because they are undervalued while managers direct resources to overvalued initiatives instead. The experience of managers at one consumer-retail company provides an example. They were convinced that the company’s lagging performance was due to a year-on-year decline in sales and promoted an effort to boost them. Increasing sales would have been good, certainly, but product margins were so low that improving sales could add little to the bottom line. Meanwhile, managers had overlooked a dramatic increase in operating costs. Cutting those offered a much richer target for bottom-line improvement. The finance function was better equipped to provide such analysis and focus management on this bigger opportunity. Valuing such initiatives often requires nuanced thinking. Although some transformations include radical changes, most create significant improvements on the margins of existing operations. That requires an understanding of the organization’s marginal economics—that is, the costs and benefits of producing one additional unit of product or service. When managers have a clear understanding of the marginal value of improving each of the activities that contribute to performance, they have the potential to redirect an entire transformation.
One cautionary note: identifying initiatives that create the most value doesn’t mean differentiating their valuations down to the last dollar. Transformations need to be fast-paced, with a bias for getting things done, because the time lost to over- analysis often represents lost value to the business.
Ensuring Benefits Fall to the Bottom Line
All too often, turnaround initiatives that could create great value never get to a company’s bottom line. Sometimes, the problem is just poor execution. At one mining company, for example, an initiative owner successfully negotiated lower rates on rental equipment with a new vendor, but then neglected to return the incumbent vendor’s equipment. Fortunately, the finance function discovered the duplicate rentals in its detailed reporting of monthly cost performance, and the company was able to quickly return the equipment before accruing further costs. But often the problem is a lack of visibility into what’s expected and too little coordination between units or functions. As a result, the savings accrued in one part of the business are offset by expenses in another. At one manufacturing company, for example, procurement managers successfully negotiated savings on a contractor’s hourly rate. But since the overall plant budget wasn’t adjusted, the plant manager ended up just using more hours on discretionary projects, and the overall contractor cost did not decrease.
Leading by Example
Helping managers clarify the value of initiatives is just the start of the CFO’s and finance function’s contribution. Just as important is how the finance function performs internally. A finance function that innovates and stretches toward the same level of aspirational goals as the rest of the organization adds to its credibility and influence. Leading by example is partly about modeling desired behavior. By taking a pragmatic view of the level of detail and rigor needed to make good decisions in the finance function itself, the CFO can set an example of good behavior for the rest of the company. For example, at one refinery operation, the CFO role-modeled a bias for action by drastically simplifying the valuation assumptions for initiatives. That enabled the operation’s leaders to focus on execution. Even though the value of these initiatives was potentially overstated by 10–20 percent, it was clear the leaders were focused on the right improvement areas. But leading in this way is also about reducing costs while increasing efficiency and effectiveness.2 Initiatives that streamline activities and cut costs inside finance also radiate throughout the organization. Simplifying processes, making access to accounting systems easier, and eliminating layers of approval or redundant reports also eliminates waste elsewhere.
Delivering Results
CFOs and the finance function can help companies successfully deliver on the full potential of a transformation. To do so, they must be judicious about which activities truly add value and embrace their roles in leading the improvement in both performance and organizational health.