Managing performance through famine and feast · Managing performance through famine and feast The CFO’s role as “economic advisor” 1. ... sharply on reducing costs in an attempt

Managing performance through famine and feastThe CFO’s role as “economic advisor”

2 Managing performance through famine and feast The CFO’s role as “economic advisor”

In this report

Dealing with economic challenges 2

The CFO’s strategic role as “business partner” 4

What it means to be a “business partner” 5

How economics can help the CFO 6

Becoming an “economic advisor” to your company 8

Enabling better economic decision-making 9

Provide strategic direction: insight and analysis of strategic fundamentals 11

Generate customer demand: insight and analysis on profit and revenue drivers 12

Fulfill customer demand: insight and analysis on the direct cost of supply 13

Provide support services: making efficient use of scarce resources 14

What building a performance management capability means for you 16

Conclusion: CFOs who drive Finance to operate as an economic advisor will be more effective business partners 18

1Managing performance through famine and feast The CFO’s role as “economic advisor”

Dealing with economic challenges


The credit crunch and subsequent recession left many organizations in a state of turmoil. As a consequence, the Finance functions of businesses in affected sectors have focused sharply on reducing costs in an attempt to protect profits in the face of stagnating or falling revenues.

However, without a clear understanding of the drivers of cost, many CFOs have found it difficult to ascertain where and how to make savings beyond the most obvious discretionary spend items. Furthermore, some of the resultant cost cutting may have alleviated the short-term pressures, but it may have had a damaging impact on the company’s underlying capabilities. These are the exact same capabilities that will be required to take advantage of any resurgence in economic conditions in order to restart revenue growth.

This type of cost reduction can be characterized as “crash dieting.” Dieters understand the difficulty of sustainability — if you opt for quick and drastic changes, you may see fast results; but the real challenge is to maintain the beneficial effects beyond the achievement of immediate, short-term goals.

The problem often stems from businesses having poor understanding of the nature of costs in terms of how they contribute to revenue, and a structural bias toward fixed costs rather than variable ones. Thus, most cost-reduction programs are constrained to focus on making arbitrary quick wins by attacking the more obvious discretionary variable costs.

With the increasing levels of confidence and talk of recovery, businesses are still focused on costs, but they are increasingly showing a level of sophistication that has moved away from the “crash dieting” approach to one that can be characterized as “cost optimization,” something similar to the concept of “lifestyle change” for those crash dieters determined to achieve long-term, sustainable goals.

There are two important lessons to emerge from this:

1. Many organizations still do not have the information nor the processes that allow for an informed transparency of the true cost base, or a clear understanding of how costs correlate to value-creating activities within the business. As a result, cost reduction strategies continue to risk being unsustainable and potentially harmful to long-term prospects for growth.

2. Despite the global trends in outsourcing and in de-risking supply chains, it has become obvious that many apparently successful businesses have continued to rely on traditional models of maintaining full control over their supply chains and the associated heavy bias toward fixed costs that goes with it. However, leading organizations have proven that switching away from fixed costs to a more variable cost base is an effective way of becoming agile enough to de-risk unpredictability in demand and vulnerability in supply; this transformation requires a change in attitude to business and operating models.

Have the lessons of the financial crash been learned and sufficiently committed to corporate memory or, as we prepare for slow growth or indeed a second recession, will the same old patterns of behavior emerge again? Will Finance professionals be able to impose financial rigor into resource allocation decisions? Can growth be driven in a sustainable way through the optimization of costs? This paper considers the role of Finance in fulfilling this obligation.


The CFO’s strategic role as “business partner”


Market studies, which include Ernst and Young’s 2010 report The DNA of the CFO*, have consistently shown that delivering commercial insight to the business is the most significant way in which Finance can add value.

For more than a decade, studies and articles have been clearly finding and recommending that CFOs and the Finance function should act more strategically and more commercially, helping to improve performance through delivering insight to business decision-makers. This role has typically been described as “business partnering,” with the CFO variously being described as a “catalyst” or “value integrator.”

Ernst & Young’s work with organizations across the globe has taught us that, while this is a commonly held view, successful business partnering is much sought, but rarely achieved.

Failure to understand the role of business partner and build the capabilities to deliver it credibly has meant the benefits expected have not materialized and the credibility of Finance to fulfill the role has been dented. This has been evidenced by the general response to the credit crunch and subsequent recession, where the lack of predictive ability and agile response has demonstrated that most organizations do not have the skills and resources within their Finance functions to manage performance during turbulent economic times. Additionally, Finance too often acts as an “observer” of performance during periods of growth and profitability, so that business results are more likely to be driven by market conditions than Finance’s ability to help decision-makers optimize market opportunities.

What it means to be a “business partner”So, how can Finance help drive commerciality into the business? Which areas of the business should Finance be concentrating on? What will enable Finance functions to provide better analytics, and become more strategic and commercial in their daily operations?

The specific outcomes and activities underpinning business partnering are poorly defined: they are often described in terms of behavioral traits, coupled with access to better quality information.

In our view, the essence of a CFO as a good business partner is someone who:

• Facilitates transparency of financial performance across their organization and works with commercial leaders to drive improved performance

• Ensures business decisions are grounded in sound financial analysis, enabled by processes that drive robust financial challenge and accountability

• Supports senior managers in strategy decisions by providing analysis and insight that prioritizes the allocation of scarce resources to areas of the business where the greatest value will be generated

• Manages the Finance function in operating from an efficient base, allowing the brightest and most talented resources to focus on value-adding analysis to support strategic and commercial operations

CFOs must demonstrate that the Finance function is equipped to manage performance through periods of growth, stagnation and contraction.

* The DNA of the CFO thought leadership paper, based on research undertaken with 669 senior financial executives in leading companies across Europe, Middle East, Africa and India, aims to provide fresh insight to the agenda of the individual CFO. It explores their changing position within the organization, their priorities and aspirations, and focuses on the skills and relationships a successful CFO will require to master the opportunities and challenges of their role. For full details, please visit: www.ey.com/dna-cfo


By reviewing the fundamentals of performance management and what business partnering should mean, we have identified the specific activities that Finance needs to concentrate on to fulfil the obligation. In doing this, we have determined that the heart of business partnering rests in practical economic theory and the effective allocation of scarce resources to achieve financial objectives.

How economics can help the CFOEconomics provides a framework for understanding how to make the best use of natural resources, assets and labor; helping us to examine the trade-offs between various choices, in order to anticipate the outcomes from decisions on changes in investment strategy, new product development, deployment of human resources, pricing decisions or production schedules.

Vital decisions like these are made through the planning and performance management process. Therefore, by making a deliberate effort to own this process, the CFO will be at the heart of economic decision-making in their organization.

Exceptionally advanced performance management frameworks make allowances for the effective allocation of limited resources, taking into account the various trade-offs, or “opportunity costs,” that exist from any options we face. These frameworks enable decisions to be assessed, based on the marginality concept; for the next unit of money you spend, how much additional profit contribution will you receive?

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. Marginal contribution is optimized and profits maximized at the point where MR and MC meet. In an ideal world, performance management systems should provide decision-makers with clear visibility about how their actions and decisions can drive toward this pivotal point.

Of course, no business operates in a vacuum and the performance management challenge is further complicated by external variables affecting market supply and demand conditions. Without making any decisions at all, a business can find that its profit maximizing position (where MR = MC) can change as a result of external activities in the marketplace; for instance, a competitor reducing their price, an increase in supply, or simply consumer-driven changes in fashion.

During the recession, the obvious market effect impacting many organizations was the drop in demand in many sectors. Consumers lose jobs and have less money, or they fear losing their jobs and spend less money; the net result is that fewer items are purchased, along with an increasing amount of switches to lower cost options. This “belt tightening” effect has forced companies to scramble to make efforts to protect their revenues and margins.

The CFO’s strategic role as “business partner” (continued)


However, it was the poor understanding of cost drivers, cost profiles and, ultimately, what leads to margin contribution, that left many organizations arbitrarily cutting costs: either this happened at a rate that was too slow to protect the company’s underlying profitability, or the cuts were too indiscriminate and risked compromising future growth; or, worst of all, it may have done both.

With the uncertainty of an economic upturn, it is clear that organizations will need to be cautious in trying to exploit growth opportunities and do so in a sustainable way. Unfortunately, the same gaps in information and understanding that impeded cost reduction attempts during the recession are also hindering efforts to manage the costs necessary for future growth.

During a period of growth, knowing how to optimize marginal revenue and contribution is more difficult to determine than simply reducing marginal costs while protecting revenues. You need to ask yourself the same question, but in reverse: rather than where should the next unit of money be saved — instead ask “where should the next dollar of investment be made?”

“ Economics is the study of the allocation of scarce resources among unlimited and competing uses” as defined by the International Encyclopedia of Social Sciences.


Becoming an “economic advisor” to your company


To optimize revenue growth and maximize profit, CFOs need to focus on understanding how to allocate the organization’s limited resources to the right areas of the business to drive marginal contribution.

As an economic advisor to the business, Finance will require a performance management capability that:

• Provides visibility and analysis of information to support the allocation of scarce resources

• Supplies the right information to the right people at the right points in the decision-making process, on both an annual and operational basis

• Is able to demonstrate the financial impacts of different decisions and scenarios to enable the organization to predict and compare outcomes against a range of alternative options

• Incentivizes executives and managers to make decisions that maximize marginal contribution, assuming this to be a sound strategic objective linked to maximizing shareholder returns

Enabling better economic decision-makingAs we have observed, the ability to take a rational, data-driven view on resource allocation decisions is critical in optimizing sustainable and profitable growth. Decision-makers want to be confident that the actions they are taking will deliver their economic objectives, or that investment strategies can be pursued without the fear that a greater opportunity is being missed elsewhere.

With organizations making thousands of resource allocation decisions a day, there is a clear dependency on timely access to targeted, relevant information by means of a fit-for-purpose performance management framework. This framework should be able to identify the most important decisions for the business, and be widely and consistently used as the mechanism for communicating them and measuring progress against targets.

However, numerous barriers can make it difficult to achieve this clarity. These barriers include systems and organizational deficiencies; but, perhaps more fundamentally, the restricted way in which performance management frameworks are structured means that important decision points do not have the right data to support fact-based decision-making. This is largely because many organizations still rely on traditional, accounting-focused management reporting, which frequently lacks the required business or operational context to drive informed decisions: variance analysis without this becomes a blunt instrument, susceptible to either generalized high-level explanations, or little more than guesswork.

So, how can this situation be improved? As well as improving systems, process and organization; any review or transformation of performance management capabilities should also consider the framework through which data is captured and analyzed. Economic insight can only be properly enabled through developing this wider viewpoint. In our work with leading business, we have found that the enterprise value chain is a very intuitive and helpful way to examine the full range of decisions a business needs to make.

Porter’s “Value Chain” is a universally accepted framework for understanding the linked activities that take place within a business. In this document, we have taken this framework and used it as the basis for demonstrating how performance management data could be improved; we have also broadened it to include important decision points across the full spectrum of organizational activity.

Building performance management capability to drive profitable growth and improvement in marginal contribution.


Porter divided the value chain into two categories of activity:

1. The “primary activities” of operations, inbound and outbound logistics, sales and marketing, and service provision

2. The “support activities” of procurement, technology, human resource management and organizational infrastructure

By applying an adapted version of this well-known framework to their company, CFOs can quickly understand where they need to be able to deliver insight to the business, and how that insight can drive shareholder returns and manage organizational performance.

The framework can be broken down into four broad sections:

• Providing strategic direction — corporate strategy

• Generating customer demand — sales, marketing and customer service

• Fulfillingcustomerdemand — supply chain, manufacturing, production

• Providing support services — Finance, HR, legal and compliance

In constructing the framework in this way, we have added a strategic standpoint to ensure that overall corporate objectives and focus are covered as part of the performance management landscape. We have also split Porter’s primary activities, so that we can easily differentiate between the supply and demand activities; this is because these two areas are usually organized and executed by discrete business units, even where make-to-order and demand-pull business models are deployed.

The resulting simplified view of performance management will enable your organization’s pressure points to be more easily identified, allowing Finance more time to focus effectively on providing the data and informational requirements needed to inform management decision-making.

We will now outline some of the most critical questions that Finance should be seeking to address, within a value chain-based performance management framework.

Becoming an “economic advisor” to your company (continued)


In many organizations today, performance management frameworks do not provide an appropriate breadth of insight; focusing instead on a narrow set of accounting or detailed operational measures that do not link back to the desired financial or economic objectives.

Provide strategic direction: insight and analysis of strategic fundamentalsBroad consensus amongst CFOs and commentators indicates that the CFO’s role (and therefore the Finance function’s remit) has gradually extended. It now includes an element of responsibility for ensuring that resources are in place to deliver the financial targets determined by the corporate strategy; also that the entire organization understands that strategy and has access to sufficient information to enable them to execute against it.

Key questions for Finance to be able to provide performance management data on are:

• What are our core competencies?

• What are our markets?

• How do we compete?

• How do we fund our strategy?

• What is the financial return we seek?

Ernst & Young case study Client situation

Our client, a large European steel producer, was experiencing weak financial results: their performance issues were pronounced in comparison with their main competitors, and a significant gap was beginning to emerge. The company has traditionally operated on a product-centric basis, with individual business units owning responsibility for revenue generation; however, understanding of their products’ end user was limited, which led to a poor and fragmented customer experience.

Our approach

Ernst & Young supported the client in developing sector-based strategies for their nine industry sectors, using profitability analysis to provide an end-to-end view of the net margin performance within business units to support the planning process. Customer satisfaction surveys were created to enable the organization to accurately assess what customers wanted and opportunity areas for focus. The joint project team worked to establish an account plan process that delivered distinct propositions for each account, and introduced a set of metrics and dashboards to help enable the executive community and business unit leads to be able to assess their sector performance on a monthly basis.

The outcome

The project provided supported strategic decision making through fact-based, analytical insights into the drivers of customer and business value. The tools and capabilities developed during the project form part of the client’s new performance management framework, underpinning changes made to the business operating model. Visions and strategies for each industry sector were articulated, together a set of focused initiatives were identified that have the potential to deliver a £3.5b revenue improvement. The project was short listed for an MCA award.


Becoming an “economic advisor” to your company (continued)

Generate customer demand: insight and analysis on profit and revenue driversThere is a tendency for Finance to place most of their focus on operational expenses and to steer clear of the “front office”, leaving this to sales and marketing teams. However, this approach ignores the considerable impact that sales volume and pricing decisions have, or how costing methods can drive huge differences in marginal contribution, or how sales and service order commitments drive different cost profiles in delivery and fulfillment.

Key questions for Finance to be able to provide the right performance management data in this area are:

• Do we understand our optimal products and services mix?

• Do we understand how our sales and marketing efforts influence revenue?

• Do we have a realistic demand forecast?

• Do we optimize our cost to acquire/serve our customers?

• Do we manage our customer working capital effectively?

• Do our pricing models properly reflect costs to serve?

Ernst & Young case studyClient situation

Our client was engaging in a wide variety of promotional activity on their brands, in order to increase sales in their target markets. However, a lack of transparency on the return on investment (ROI) of their promotional activity meant that there was no clear understanding of how the promotional activity impacted the bottom-line profitability, as well as the top-line revenue.

Our approach

Ernst & Young collated sales data by promotional activity and incentives (percentage discounts, buy one get one free, etc.) across a number of markets, in order to determine the ROI delivered by each of the promotions. Tactical interventions were identified to stop promotional deals that did not meet ROI hurdles, which immediately improved bottom-line profitability. Promotion guidelines were then created, to help structure future activity.

The outcome

The company has seen a significant increase in the financial returns from their promotional activity and has implemented a rigorous process to ensure compliance across the organization. Benefits of the consistent application of the promotional guidelines were £20m of incremental contribution.


Fulfill customer demand: insight and analysis on the direct cost of supplyA clear differentiator between organizations that successfully navigated the credit crunch and those that floundered was the flexibility and agility of the company’s cost base and its ability to react swiftly to changes in demand. From an economic perspective, this is the ability to move the supply curve in reaction to rapid changes in the demand curve.

Key questions for Finance to be able to provide the right performance management data in this area are:

• Do we understand how our cost of supply varies with changes in volume?

• Do we understand when to make investments in new assets as opposed to the maintenance of existing ones?

• Do we have a realistic production forecast?

• Do we understand how to allocate our costs to our products and services?

• Do we manage our supply chain working capital effectively?


Our client was suffering from a flat top-line growth in their UK business which, compounded by high input cost and commodity inflation, was driving an acute need to review their supply chain and deliver improved cost-efficiencies. However, the lack of transparency across multiple profit-and-loss accounts within the company resulted in a limited overall understanding of the end-to-end impact of cost improvement opportunities.

Our approach

In an accelerated period of seven weeks, Ernst & Young built a model for the US$1bn market in the UK to identify our client’s total delivered cost (TDC) profitability; looking at it from all levels — customer, channel, brand and product. The transparency gained through the TDC profit model enabled us to identify a number of improvement opportunities, which were subsequently prioritized and underpinned by detailed implementation plans.

The outcome

By adopting the TDC approach, the company identified multi-million dollar cost-saving opportunities in the UK division alone: these savings are now being delivered with an increase of 0.5% to their forecasted bottom line. The TDC model has now been scaled across the rest of the European region.


Provide support services: making efficient use of scarce resourcesThe CFO should lead the organization’s efforts to understand and make efficient use of scarce resources. From an economic viewpoint, Finance must challenge decision-makers to think in terms of allocating indirect resources in a way that is data driven and will maximize the return for the company.

Key questions for Finance to answer are: • Do we understand and measure our performance against

our targets?

• Do we have the skills we need to provide insight analysis to the business?

• Do we incentivize our people to deliver our organizational targets?

• Do our operations optimize our balance sheet?

• Do we communicate our performance to external parties effectively?


Our client, a local authority, anticipated a 20% cut in funding over five years and a forecast rise in costs of 19%. Their focus on cost reduction needed to be balanced carefully with the continued provision of essential local services.

Our approach

We established a deep understanding of the drivers of current and forecast costs, using analysis tools and techniques which the Finance and service teams could use on a repeatable basis. This analysis provided transparency of the areas with savings potential for the local authority. We then facilitated a process through which the client’s corporate management team confirmed and validated priority outcomes and services which enabled them to undertake decisions on services to be reduced, retracted or transformed. The process required collaborative working between directors, Finance and service delivery teams, to identify opportunities to address the gaps in funding for priority areas.

The outcome

The council’s corporate management decision-making process was informed by fact-based analysis, and that helped enable the council leaders to make a series of fundamental decisions regarding the future allocation of rate payers’ money to ensure appropriate focus on priority services while identifying £127m of run-rate, enabling the local authority to develop a delivery plan that will help ensure they meet future budget constraints in five years’ time.



What building a performance management capability means for you


Step 1Identify the most critical decision points that drive economic performanceFinance is the well-positioned function with an overview on economic return cause-and-effect to be able to identify where marginal contribution can be maximized to deliver profitable growth.

Finance must be able to provide insight on the decisions that create or protect marginal contribution right across the value chain; assessing the organizations’ fixed and variable costs, then identifying and measuring how and where growth in sales translates to growth in profits, and, where applicable, how reduction in costs can maintain revenues while improving profit contribution.

Critical enabler: strategic business understanding within the Finance function

Step 2Establish a clear, forward looking line of sight on relevant data for critical decision pointsFinance must have access to a robust data set, built around the decisions that drive most economic value in the organization.

This demands trust in, and accuracy of, the underlying data and its sourcing. It also requires understanding of how the data relates to the value chain decisions; however, it does not necessarily mean a large investment in systems or business intelligence tools designed to report, analyze and present data.

Critical enabler: embedded data quality and governance in management information

Step 3Develop aligned performance management processes that drive rational decisionsFinance must be able to translate this insight and understanding into the desired end product — rational decisions that maximize the desired economic return.

Achieving this means that planning, budgeting, forecasting and reporting processes must be aligned to the right measures; and incentive programs must be linked to targeted economic outcomes. Changes to these processes should be linked to sustainability of cost reduction, or margin improvement exercises: they should not be approached as one-off CEO/COO sponsored projects with a short-term focus.

Aligning traditional resource allocation processes to the executive objectives helps ensure repeatability and change to the culture and sustainability of the organization, through the on-going discipline of challenging resource allocation decisions to ensure optimization of marginal contribution.

Critical enabler: aligned planning, budgeting, and forecasting process closely linked to employee reward and recognition processes.

Step 4Ensure compliance and make sure that Finance’s voice is heardFinance must be the guardian of performance management, checking that agreed processes are followed so that the desired outcomes can be achieved.

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 have an advanced level of communication and influencing skills to ensure that their voice is heard and their advice is valued and acted upon.

Critical enabler: communication and influencing skills within the Finance function


Conclusion: CFOs who drive Finance to operate as an economic advisor will be more effective business partners


Ernst & Young have set out a framework for understanding the role of the CFO in achieving profitable growth: the fundamental conclusion is that using the “CFO as economic advisor” as a transformational framework will help ensure that improved financial performance will be the primary driver of everything that Finance does above and beyond the basics of ensuring statutory, regulatory and fiscal compliance.

The framework helps CFOs quickly determine where they need to be able to deliver insight to the business, and how that insight can drive effective cost optimization and profitable growth. It does not involve a radical new paradigm; it draws on universally accepted value chain fundamentals.

We believe that by using this framework, CFOs will be able to channel their function’s performance management efforts toward providing insight in the areas that will be of most value and, in doing so, they will successfully fulfill the aspirational strategic and commercial role that should be at the heart of successful business partnering.




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Managing performance through famine and feast · Managing performance through famine and feast The CFO’s role as “economic advisor” 1. ... sharply on reducing costs in an attempt