What is Managing performance through famine and feast about?
We want to help you get to the insight you need as quickly as possible. This is one of a series which summarizes the key findings from Ernst & Young reports from the perspective of the CFO and future finance leader.
CFOs who understand the true correlation between cost and value — the basic economics of the organization — are the real “business partners.”
For the past few years, many businesses have focused on cost reduction to alleviate short-term pressures and preserve profits. Often, however, companies have focused on “quick wins” by attacking variable costs without fully understanding how those costs contribute to revenue.
They do this because:
- They lack the information or processes to understand the cost base fully, or how costs are linked with value creating activities.
- There is a structural bias toward fixed costs.
- A reliance on traditional, accounting-focused management reporting means that finance functions lack the required business or operational context to drive informed decisions and help decision-makers optimize market opportunities.
- Some CFOs spend too much time focusing on operational costs and not enough on how decisions in the front office support the business.
Despite the much reported requirement for CFOs to act as “business partner,” those who are unable to identify where to cut costs and reprioritize spend to value creating areas will continue to be hindered in truly delivering this aspect of their role. Managing performance through famine and feast considers the role of the CFO in driving sustainable growth through the optimization of costs and what it is to be a true business partner.
The CFO as an “economic advisor”
To enable their business to thrive in good times and bad, CFOs need to develop a stronger focus on the economic and performance drivers of their business. To become an effective business partner, CFOs need to understand how the effective allocation of scarce resource will help them achieve financial objectives.
Economics provides a framework for understanding how to make the best use of resources, assets and labor, and examining the trade-offs between different choices. In turn, this will drive a better understanding of the potential outcomes from changes in investment strategy, resource allocation, new product development, pricing or production.
In microeconomics, marginal revenue (MR) is the extra revenue that an additional unit of product will generate; marginal cost (MC) is the additional cost of producing that extra unit. In an ideal world, performance management systems should provide decision-makers with a way to optimize marginal contribution and maximize profits at the point where MR and MC converge. These decisions take place through the planning and performance management functions. By owning these processes, CFOs will find themselves at the heart of the economic decision-making in their organization.
To be a business partner and advise on the effective allocation of resources, the CFO must build a performance management capability that can:
- Provide visibility and analysis of information to support resource allocation
- Support the decision-making process by providing the right information to the right people at the right time
- Demonstrate the financial impacts of different decisions and scenarios to enable the organization to predict and compare outcomes
- Incentivize executives and managers to make decisions that maximize marginal contribution
- Enable a data-driven view on resource allocations across the entire value chain (to include corporate strategy; sales, marketing and customer service; supply chain manufacturing and production; finance, HR, legal and compliance)
Identify the most critical decision points that drive economic performance
With a unique perspective across the entire business, CFOs can provide valuable insight into the decisions that create or protect marginal contribution across the value chain. Armed with a detailed understanding of how and where growth in sales leads to growth in profits, they can offer an objective assessment of fixed and variable costs, and then identify how a reduction in costs can maintain revenues while improving profit contribution.
Establish a clear, forward-looking line of sight on relevant data for critical decision points
Finance must have access to a robust data set, built around the decisions that drive most economic value in the organization, including assessment of opportunity cost. This demands accurate, verifiable underlying data and an understanding of how the data relates to value chain decisions. This will enable the CFO to conduct scenario planning around these different decision points.
Develop aligned performance management processes that drive rational decisions
Finance must be able to translate insights and understanding into the desired end product — rational decisions that maximize the desired economic return. Aligning traditional resource allocation processes with business objectives helps ensure repeatability and the sustainability of the organization.
Ensure compliance and make sure that finance’s voice is heard
The CFO and finance function must be positioned appropriately within the organization to be able to influence decision-making and action. Additionally, finance professionals must improve communication and influencing skills to ensure that their voice is heard and their advice is valued and acted upon.