How to ensure your central finance function is adding value, not creating bureaucracy

Transcription

1 How to ensure your central finance function is adding value, not creating bureaucracy Is your finance function helping build the business, or merely bogging it down in bureaucracy? Andrew Campbell describes a challenge process for ensuring your central finance function adds value Andrew Campbell is director Ashridge Strategic Management Centre and the author of 10 books on strategy and organisation, including the classic text Corporate Level Strategy I am from head office and I am here to help is a common joke. This is because head office functions are so frequently either unhelpfully bossy or bureaucratic or both. Most central functions are seen as a source of extra work, rather than extra help. Finance is an example. Managers in business units frequently complain that group finance makes endless information requests, but never gives anything of value back. If not asking for information, group finance is felt to be imposing policies and processes that often seem inappropriate when implemented in the local situation. So how can CFOs make sure that their central finance team is a source of added value rather than bureaucracy? The answer is that CFOs should set up a process to rigorously challenge every activity that is centralised and every plan to increase centralisation. The objective is not principally to reduce the amount of centralisation, although sometimes this is the result. The main aim is to make sure that centralised activities are focused on adding something important to the success of the company. In other words, the objective is to avoid policies, processes or functions that are bureaucratic or self-serving. The necessary challenge process for achieving this objective should involve the following three questions. If the answer to the first question is no, ask the next one. If the answer to the second is no, ask the third. And if the answer to the third question is no, abandon the activity since it will almost certainly be a source of time wasting and bureaucracy 1

2 1. Is the activity non-discretionary? The first challenge is to ask whether performance of the activity involves any choice. Does this activity have to be done because of legal or stakeholder requirements or as part of basic controls? Also, if it does have to be done, does it have to be done at the group centre? For example, the annual report and accounts and related filings are required by law. Moreover, it is impossible for this task to be delegated to the business divisions. It must be done in the group centre. In contrast a system for budgeting and financial forecasting is discretionary: it is not required by law or by external stakeholders. While it is a common feature of most companies, there are successful companies, such as Virgin Group and most private equity firms, without central budgeting processes: each business division has its own process. Also some essential activities, do not have to be centralized. For example, significant investment decisions need to be supported by a business case. This is an essential part of the control system. But the business case does not have to be developed by a central finance team. Business divisions can do their own business analysis. Non-discretionary items that must be carried out at the centre need no further challenge. They may feel bureaucratic to the business divisions. They may even be time wasting. However, since they are required, further debate is unhelpful. The CFO needs to benchmark these activities against other companies to make sure they are executed efficiently; but he or she does not need to challenge them further 2. Is the activity designed to add (or help add) significant value? For those activities that are discretionary (i.e. the answer to question 1 is No ), the next challenge is about adding significant value. If the activity is designed to add significant value, it does not matter if it takes up the time of managers in the business divisions or distracts them from other priorities. The gain is likely to be large enough to justify the pain. Of course it makes sense to execute these activities efficiently. But, they are unlikely to be a source of bureaucracy or time wasting. So what constitutes significant added value? We have found that 10% is a practical hurdle: will the activity add 10% to the market capitalisation of the group or to the overall profits? If not, and as you might expect, most finance activities do not meet the 10% test, then it is reasonable to ask is the activity a necessary part of some larger initiative that will add 10% to the market capitalisation of the group? Why is 10% a reasonable hurdle for this test? First, from practical experience 10% appears to limit the significant central initiatives to a manageable number of between three and seven. Second, each significant initiative takes up some of the organisation s scarcest resource top management time. If the initiative is 2

3 not aiming for at least 10% improvement, the opportunity cost of the senior management time may well exceed the benefits of the initiative. Consider a typical finance initiative: standardising on SAP enterprise software across the company. If the finance team can argue convincingly that the project will lead to a 10% increase in profits through cost reduction or additional revenues, then it makes sense. If not, the project fails this hurdle and should be tested against the third and final question (see below). As already mentioned, some finance activities do not meet the 10% hurdle on their own, but may be an important supporting activity to an initiative that does meet the hurdle. For example, performance management can be a major source of added value. Stretch targets and tight performance monitoring can often squeeze out an additional 10%. Finance may not be leading the performance management effort, but is likely to be providing vital support. Finance may provide the numbers and suggest suitable targets (in fact a common SAP system may help with this). Finance will help spot variances and suggest ways of getting back on track. Finance may even be the keeper of the list of to dos, and check them off as each is completed. None of these activities on its own adds 10%, but, as part of a performance management system, together they would pass this hurdle. Unfortunately, most groups do not have a clear list of their main sources of group added value (for an example of such a list see the box The group added value of a global logistics company ). This can make it hard for the CFO to judge whether central activities such as the budgeting process or the process for monitoring variances or the M&A unit are part of larger initiatives that generate 10% improvements. If there is no list, the CFO will need to propose his or her own list of major sources of group added value and how group finance links to them. Without a list of the significant sources of group added value, there is little focus for any of the group functions. So raising the issue with the CEO and executive colleagues can provide clarity for more than just finance. 3. Is the activity a minor source of added value AND set up to ensure low risk of negative side effects? There are many areas where economies of scale or skill suggest that centralisation is likely to deliver lower costs or higher quality, but the benefits do not amount to a 10% improvement. For example, centralising payroll in a large company may save some millions of dollars of administrative costs, but it will not improve the market value of the company by 10%. In the same way, centralising credit assessments of suppliers is likely to lower the cost of making the assessments and improve the average judgment. But, is unlikely to add 10% to profits. Be wary of these minor sources of added value that do not pass the 10% test. They are often the major source of bureaucracy and time wasting. Because the added value they bring is small, they will probably distract senior managers from more important activities. Alternatively, if they are left to junior managers, they can become inefficient or overly complex, and they can result in frustration 3

4 within the business units, as more and more activities are stripped away from business unit control. So minor sources of added value should be pursued only if the risks of bureaucracy, inefficiency, distraction and de-motivation can be kept to a minimum. This is where a CFO s influence can be most powerful in finding the right balance between centralisation and decentralisation. The CFO should say no to these minor sources of added value activities, unless he or she is convinced that the initiative has been designed so that the risks of negative side effects are low. Take the idea of a central credit assessment team. The risk of negative side effects would be low if the team was to be led by someone with a track record for efficient credit risk analysis; was visibly targeted on cost per assessment, speed of service and quality of judgment; was to report to a head of shared services (hence not take up the time of senior finance people); and had the support of business divisions because they saw it as a burden taken from them rather than an additional control over their freedom. If, on the other hand, the proposed head of the team did not have a strong track record, the KPIs for the unit had not been specified and the CFO was likely to have to invest time in soothing the concerns of business unit leaders and monitoring the performance of the new unit then the risks would be high and the CFO should say no. It is better to leave some value on the table, than set up an activity that risks doing more harm than good. Conclusion Why effective challenge is so important The reason why the described challenge process is so important is because group functions are often sources of negative rather than positive performance. Moreover, group strategy frequently fails to give clear guidance to those group functions about what their agenda should be. The group strategy may define priorities in terms of segments and geographies and technologies. But it rarely defines priorities in terms of centralisation or added value. This means that CFOs get only a limited briefing either from their boss or from the executive committee about how far they should centralise. They normally develop their own agenda, propose it to the CEO and the executive committee and judge what to do based on the responses they get. So they need a process for challenging their own thinking, because they frequently do not get enough challenge from their bosses. Strong challenge is particularly important in the current environment, when many companies are looking for extra cost savings and controls. At times when centralization is on the agenda, it is easy for the pendulum to swing too far. Hence, right now, CFOs need a powerful way of deciding what to centralise and what to leave in the business units. The three questions provide the framework. Judgment is still required. But, by asking the three questions, CFOs will be teaching their functions how to add value without creating bureaucracy or resistance from business units. 4

5 Finance role in major sources of group added value in a global logistics company A. Guidance on investments, business models and contract terms - Finance role check business cases, develop financial models, provide analysis support to business units B. Coordination of business unit relationships with major customers - Finance role - calculate profitability by customer across all business lines C. Coordinate of business unit activities in selected less-developed countries - Finance role - none D. Centralisation of selected specialized operating activities, such as aviation - Finance role - provide finance business partners and accounting services E. Efficient financial and tax structure - Finance role - lead the development of efficient tax and balance sheet structures How to identify the activities to stop 5