The Master CFO Series:
A tale of two markets
10 lessons for CFOs
Each company must strike a balance between developed and rapid-growth markets that is appropriate for its sector, strategy and growth prospects. And it must communicate that strategy in a way that meets the different needs of its different investors.
The enthusiasm for rapid-growth markets, and a belief that they represent the single most important source of sustainable long-term growth, can lead companies to over commit to them.
But despite this need to adopt a specific approach to resource allocation and investor communications, there are a number of key lessons that will be applicable for just about any company.
1. Ensure that resource allocation changes in line with growth expectations.
CFOs should apply financial discipline to resource allocation decisions by ensuring that budget for capital expenditure is kept in line with the company’s expectations for growth in revenues for each market. By keeping tight control over these metrics, CFOs can apply an objective yardstick for changes in investment.
2. Do not neglect developed markets.
The enthusiasm for rapid-growth markets and a belief that they represent the single most important source of sustainable long-term growth can lead companies to over commit to them. For the foreseeable future, developed markets will be a core source of profitability and cash flow, so they must also be given the resources they need to thrive.
3. Prioritize markets but make sure that there are options to shift allocations accordingly.
It is not possible for companies to invest in every opportunity. CFOs must therefore play a vital role in helping companies to prioritize markets according to the company’s willingness and ability to invest, and their fit with the company’s strategy.
But they should also ensure that there is a range of options built into this prioritization. This involves companies being able to demonstrate to investors that the company has the flexibility to scale investments up or down in line with changing opportunities and risks.
4. Consider how the risk profile of an investment might change over time.
Many companies apply higher discount rates to rapid-growth market investments to reflect the greater potential risk. But one problem with this approach is that it assumes the same level of risk over the entire lifecycle of the investment. This can put the company at a disadvantage in a competitive bid situation.
An alternative approach is to set a group cost of capital based on an expected portfolio of investments and funding that enables the company to risk-adjust cash flows rather than changing the discount rate.
5. Scaling down can be just as difficult as scaling up.
Increased allocation to rapid-growth markets will often mean a decreased allocation to developed markets. Selecting the assets that will receive less allocation requires similar decision-making rigor as those to be scaled up.
Shrinking allocations to slow-growth markets also poses management challenges. CFOs must ensure that they explain the rationale for decisions to internal stakeholders and be comfortable that managers understand the “big picture” reasons for changing allocations.
6. Incentives in growth markets should change over time.
In immature markets, companies prioritize growth and market share as the key metrics. But as these investments mature, there should be a shift toward metrics that incentivize efficiency.
A good yardstick is that, year on year, the investment should spend less to achieve the same quantity of sales.
7. Investor relations need to move up the CFO’s agenda.
Above all else, investors want to understand changes in the risk profile so that they can factor these into their decision-making. This trend highlights the importance of communicating more frequently with investors and of bringing them along on a journey as the company’s strategy evolves.
8. CFOs must understand the divergent needs of their investor base and be able to reconcile conflicting priorities.
Investors vary widely in their risk appetite, time horizon and goals. Some may be looking for companies to return cash via share buybacks, while others will be looking for longer-term investment in rapid-growth markets.
CFOs will not be able to please every investor, but they must understand their divergent needs and construct a portfolio that, as much as possible, satisfies different sections of their investor community.
9. Consistent metrics in allocation decisions help to keep surprises to a minimum.
Investors expect consistency in the way in which companies reach their decisions on resource allocation.
By being transparent about the rationale for a company’s chosen strategy, and explaining clearly the investment criteria and definitions of success, the CFO can give investors certainty and confidence that surprises will be kept to a minimum.
10. CFOs must strike a careful balance with their disclosure of information.
Investors will expect greater disclosure about key risks and opportunities in line with an increased allocation to rapid-growth markets. But CFOs must be careful how much they disclose.
Give too little information away, and investors will become nervous and react badly when unexpected news emerges. But give too much away and there is a risk of introducing undue volatility to the share price and imparting sensitive competitive information.