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Sonax Group

Better times lie ahead for financial decision makers, but the building blocks needto be put in place now.

The Setting: An Executive Suite Circa 2012

The plasma panel hanging on the wall dissolves from a graph of year-to-date sales by region into a series of real-time feeds of key business measures: orders received, inventory levels for key products, shipment status for the 10 largest customers, call center volume and website activity. Occasionally, one of the quadrants dissolves into a specific alert about potential threats or opportunities — a change in the buying pattern of one customer, a quality issue with a batch in a supplier’s plant. The top-right quadrant shows a map of sales by region, and an icon allows the view to be changed to sales by product or by customer. Again, opportunities and threats are highlighted, such as below-quota sales in one territory or a close-rate problem in another. The lower-left quadrant provides a business risk “heat map” addressing key risk factors across multiple dimensions — financial, competitive, regulatory and project-related. Senior managers review the heat map during their regular operations reviews and as input to the rolling forecast process.

Out in the field, a sales associate can see that a shipment for one of his biggest customers is delayed on the loading dock and will ship 20 minutes late. He sends a quick alert to the customer communicating a revised delivery time, which triggers a message to the mobile email devices of both the shipping manager and sales manager forecasting a slight shortfall in monthly performance. Both act quickly. The sales manager authorizes the rep to offer a discount for the performance shortfall; the shipping manager adjusts the staffing schedule to avoid any further delays in vital month-end shipments. These changes trigger an alert on the CFO’s performance monitor showing a negative variance in labor costs, but she is unconcerned. The extra investment drives on-time shipment performance up by a few percentage points, which she knows will directly translate into improved customer satisfaction, and the 12-month rolling trend for labor costs is still well within the acceptable range. The CFO’s mind flashes back to the bad old days before performance management, when she would have been lambasting the shipping manager for a negative labor variance compared against the budget he had developed more than a year earlier. In response, he would have reduced labor costs, thus driving a dangerous decline in shipping performance and setting up a major customer relations problem that she would have spent the next three quarters trying to explain to Wall Street. But with performance management in place, she had the right information and rational bases for comparison that allowed her to make the right decisions for the overall business.

Snapping back from her reverie, the CFO turns her attention to the recent uptick in orders from Southwest China â€” a 20 percent spike in the last 72 hours. Her screen shows that this follows the rollout of a new series of advertisements on Asian YouTube. She suggests to her colleague, the VP of marketing, that the program be expanded since the company has plenty of flexibility to ramp up supply in this crucial new market.

The forecast for the month is dynamically updated to reflect the increased marketing spending and expected orders, and the CFO clears the updated forecast for publication. Meanwhile, the CEO, who is delivering a presentation to the board, is able to communicate an upbeat assessment of future prospects based upon growth in China, while acknowledging that work remains to be done in the fulfillment process.

An analyst supporting the VP of operations is reviewing the latest project status reports for the top five projects currently in progress. He sees that there are delays in two of the projects. Further drilldown indicates that the issue is a shortage of available testing engineers because both projects need access to the same resources. He starts to develop an impact assessment and sees that there is enough contingency built into one of the projects to absorb the delay while any delay in the other will likely affect the ship date for a new product. He apprises the VP of operations of the problem, diagnosis and recommended course of action, which is quickly approved after consulting with the two project managers. The VP comments that this is exactly the sort of timely, insightful analysis he wants and vows to pass his compliments on to the CFO. The analyst enters the approved action plan into the system, and the work schedule for the testing group is updated, as are the plans for each project.

Sound farfetched? It isn’t, really. Many of the component pieces exist today. Unfortunately, few companies have developed a complete vision that allows them to construct the road map to a dynamic, risk-aware performance management process. The pace of change in performance management over the last few years has been dramatic, and there are few signs of a slowdown.

So what does the future hold and how do we prepare? Let’s take a time-out from the hectic day-to-day and look at the attributes of a world-class finance organization in 2012.

Building for the Future

Dare we hope that mind-numbing six-month budget processes, sandbagged forecasts and the avalanche of incorrect management information are things of the past? Will we fondly remember the futile arguments over internal cost allocations and lament the passing of Excel spreadsheets attached to email messages as the primary vehicle for budget development? The answer is that we have no choice. If these inefficient activities remain the foundation of our management processes, we will be hurtling toward irrelevance as more agile competitors or dynamic market changes leave us scrabbling in the dust searching for the one version of the budget that contemplated this reality.

CFOs must set an ambitious goal: to eliminate all the excuses for poor decision making. No longer will managers be able to blame computer systems, the lack of timely and relevant information or the absence of credible analysis for making the wrong decision — the only excuse left will be their own ignorance. The CFO’s mission is to isolate “management stupidity.”

So how do we go about building a set of financial and management processes, systems and behaviors that fulfill this mission? The following are the basic rules that need to become embedded in the CFO’s performance management vision.

Management processes must follow the rhythm of the business, not the turn of the calendar.
Real time has been the clarion call of business information systems for close to 30 years. Only now is the reality beginning to match the hype. Historically, finance has followed episodic, calendar-driven processes, where actions were dictated not by events in the marketplace but by the turn of the accountant’s calendar. Activities are preprogrammed on daily, weekly, monthly or quarterly schedules. Any disruption to the schedule places major strain on the finance team.

Things are changing, however, for the better. The increasing availability of real-time performance tracking supported by tolerance or exception-based alerts will provide managers with a valuable early warning of potential opportunities or threats. Finance must become more event-oriented as it tunes its practices and processes to the daily rhythm of the business.

Relevant content must drive decision making.
Most budgets and reports focus on the irrelevant. There are line items for rent, office supplies and telephone costs; when was the last time a company photocopied itself into bankruptcy? Where are the line items for innovation, customer attraction, customer retention and employee retention? Look at your plans, budgets and reports, and ask yourself a simple question: “Are these items the most important for the success of our business?” The problem is that what we typically plan and budget for is not what’s strategically important for the business. We are stuck in an accounting-centric view of the world that bears little relation to the practical reality of the things that will determine whether we are successful or not. Organizing plans around the things that matter is a crucial step on the road to relevance.

Risk-aware management processes will be the norm.
Increasingly, CFOs are also serving as chief risk officers. Today most of our management processes are predicated on certainty and accuracy, both of which are fatally flawed assumptions. Budgets provide a specific profit number; forecasts offer a single and often very detailed view of the future. This is dangerous and leads to a degree of confidence in the future that has no basis in reality. Variability and uncertainty are the norm when looking ahead. The only certainty about any plan or forecast is that it will be wrong in some way; success is determined by the speed with which an organization can detect change and respond positively.

Progress is being made in this area. Real options, scenario planning, contingency planning and rolling forecasts all recognize the crucial importance of understanding risk in performance management. At the best companies, these tools are being combined with an enter- prise risk management model that has evolved from a discrete “audit-like” function to an integral part of the overall management process. Risk management is not just a finance job; it’s the job of every individual in the organization.

Performance management systems will integrate seamlessly.
Seamless integration has been the holy grail of IT for several decades now. Despite what many seem to think, attaching spreadsheets to emails does not constitute integration. The true measure of performance management value is achieving better performance through better decision making. A key enabler is the ability to source, synthesize and deliver the total sum of an organization’s collective knowledge about a subject into the hands of decision makers, be that a customer service agent dealing with a complaint or the CEO deciding whether to make an acquisition. The ability of performance management systems to tap in to both internal and external sources of data will be a hallmark of success, and the responsibility for this sits squarely in the office of finance.

Ubiquitous, situationally relevant management information will become available.
Moving beyond real-time, alert-based information, performance management systems will routinely structure and deliver information that is not just relevant for the individual based upon his job but also upon his situation. This applies to both the delivery channel (email, text message, voice mail, message to a vehicle’s satellite information system, etc.) and the context of the decisions being made. Information will be organized around the decisions they are making. For example, thinking of hiring a new employee? Compensation, benefits and demographics information on the characteristics of the most successful past-hires will be grouped together and delivered as an integrated information “packet.”

Incentives will reward performance, not plans.
One of the pernicious attributes of many planning and budgeting processes is the level of “sandbagging” that is induced by tying an individual’s rewards to achievement of plan or budget. It is a surefire certainty that you never get a stretch plan from a manager whose incentives are directly linked to its achievement. More damaging are the following situations:

1. Plan sets a growth target of 10 percent. The company achieves growth of 15 percent, so everyone gets a big bonus. But what if the market itself actually grew 20 percent? Did management perform or were they simply rewarded for having a bad plan?
2. Plan sets a target of 10 percent. The company only grows 5 percent, so no one gets a bonus. But what if the market was flat? Should managers be penalized for gaining five points of market share?

The focus must be on rewarding performance, not plans. It’s much better to tie incentives to measures that are difficult to sandbag, e.g., absolute performance improvement or performance relative to an established peer group or benchmark, as shown in the payout matrix in Figure 1.

Conclusion

The recurring theme is relevance. Information, processes tools, systems and even incentives must be relevant if they are to be effective. CFOs and the teams following these design principles are driving real performance improvement through a better understanding of risk, uncertainty and returns. Finance teams are also on the hook to deliver timely, relevant information and analysis that allow their organizations to manage risk more effectively and make better, faster decisions, thereby driving market-leading improvements in performance.