Achieving Efficiencies Through Strategic Planning
A large-scale system, whatever its purpose, naturally requires more deliberation and engineering than a small one. Respiration for single-cell life is just simple chemical diffusion. Big multi-cellular organisms need valves, pumps, miles of plumbing, and an integrated control system to do the same job.
Likewise as corporations grow, their various inter-functional connections – once coordinated over coffee or a beer – need to be completely re-thought and re-designed in order that they may fit together in ways that work on both macro and micro levels. If this does not happen, the results are predictable. Catastrophe looms. Heroic acts are performed, or not. If the company survives one stage of growth, the theme is recapitulated in a crescendo of jarring severity.
Two ways out are available: management technology and buffers. The road taken is usually obvious. A supply-chain without modern coordination-technology will have large buffers: excess inventory and premium freight. Similarly, Treasury departments lacking functional intra-corporate integration are characterized by excess cash and bank fees.
Treasury’s connection to Strategic Planning is perhaps the single worst interface in today’s large corporation. Communication and coordination are at best minimal on this important axis. The consequences for the implementation of long range plans are bad: a lower than necessary probability of success and needlessly slower progress toward goals.
Treasury is not the only area with a dysfunctional interface to Strategic Planning. Thomas C. MacAvoy, former President of CorningIncorporated and a leading contributor to the field of innovation and technology strategy1 compares treasury to manufacturing in its relationship with theinnovation process: “The manufacturing people will often tell the development people’We make the money. Call us when you actually have something to produce.’ When development goes ahead without their involvement, manufacturingwill often complain about the processthey are expectedto scale-up. Treasury is the same way – paying little attention to development until it’s time to launch the new product. They should be in from the beginning, but in the early stages the numbers are too small to interest them. Strategic innovation requires teamwork, and not just a hand-off process.”
Treasury’s financial responsibilities range from very short time-horizons through the very long. Intra-corporate integration issues span a parallel spectrum. Perhaps unexpectedly, performance is best at the shortest timeframes. Cash Management’s ability to coordinate effectively with Purchasing and Credit Management dates to the widespread implementation of ERP – and its communal database – in the late 1990s.
Even here there is a problem that points to the source of integration trouble out in the strategic timeframe. It is an invisible seam in medium-range data where time-buckets switch from being filled by real orders to forecasted ones. This forms a rolling stumbling block to concrete plans. Beyond it ERP’s sales, production, and purchase orders wink on and off like a meadow of fireflies.
Dealing with the expanding uncertainty that comes with financial issues progressively further out into the future is understandably exasperating enough for people who need to move exact amounts of real money. It is worse when the managers responsible for these time-series do not appreciate the fundamental difference between ‘forecasts’ and ‘goals’. All of Strategic Planning exists on the far side of the ‘uncertainty seam’. This is the main cause of its disconnect with treasury.
Recently, I asked the Treasurer of a Fortune-500 diversified manufacturer how he used the corporation’s composite strategic plan. He opened a drawer and produced two pieces of paper. One was the current year’s Finance Summary page. It consolidated the historic and projected cash flows of the company’s hundred-plus businesses. The other page was the previous year’s summary.
They were remarkably similar. The growth rate in revenue and profitability turned steeply higher at the elbow between past and future years on both pages. In the vernacular of strategic forecasters, this pattern is called the “hockey-stick”. The past is fixed and numbers are good. The future, however, is intrinsically variable. Worse, instead of true forecasts, each of the business units was publishing hopes and dreams, i.e., goals.
“If I were to use this,” he winced, holding the Strategic Plan at arms length with a forefinger and thumb, “the company would be in the ditch.”.
While corporations have been planning ‘strategically’ for many generations, Strategic Planning as a discipline took its first leap forward as a management technology in the middle 1970s with the introduction by the Boston Consulting Group of a four-quadrant approach to Strategic Business Unit (SBU) classification called the Growth/Share Matrix. Other variants subsequently appeared, such as the GE and the McKinsey Matrices.
The original BCG innovation introduced a startlingly revealing two-dimensional concept-space. One axis spread a corporation’s SBUs out by market share. The other coordinate plotted the growth-rate of their respective markets. The idea here was that once the company was properly divided into SBUs, each could be plotted on the matrix using these two numbers and its ready-made strategy instantly printed off.
For nearly a decade, this matrix was the single most expensive consulting product sold to senior management. Then, just as suddenly as it arose, the Growth/Share Matrix collapsed. Practitioners claimed its ruin was caused by a lack of proper implementation. Others opined that the matrix was just too simplistic, that no strategy can be based on only two conceptual dimensions.
Actually, the simple truth is more likely that the young MBAs working the infant management technology in the business world’s many new Strategic Planning departments were woefully unprepared for the fierceness of the battlefield – and the single-mindedness of its hardened, pin-striped warriors – that is the annual corporate budgeting ritual. There were also junk-bond LBO-raiders roving about, generating an intense pressure to reduce corporate staffs. In any case, the late 1980s suddenly saw Strategic Planners slaughtered wholesale and heaped like cord-wood by the curb outside headquarters throughout the corporate space.
Senior management, however, had come to realize that they needed a process to connect their visions and their budgets. So as Boesky and Milken were marched off to prison, the pendulum swung back. Planning departments re-grew, more cautious this time about sweeping edicts and never publicly labeling anyone with slurs like ‘cow’ or ‘dog’.
There is more to connecting corporate treasuries and Strategic Planning departments than simple conversational ice-breaking. The interface must become an extension of both disciplines – their systems and technologies. Just as the selection of appropriate Treasury operating procedures depends on a relative handful of corporate variables, the shape of Strategic Planning contours to the organization being planned. In between, five primary factors determine the proper nature of this interface.
These are all very highly inter-reactive issues, so you might envision the zone as a five-dimensional concept-space. Here, however, we will limit the discussion to the discreet effects of these variables and leave the analysis of their interactiveness to perhaps a book-length treatment of the subject.
As a practical matter, Strategic Planning can be constructed in either a “top-down” or a “bottom-up” configuration. Both formats allow for multiple iterations, of course, but the five determinants here will nearly always point to the better approach of the two.
Capital Consumption or Production
There are only two honest ways for a corporation to consume capital, lose money or grow fast. In either case, the pipe connected to the in-bound capital pump nearly always has a finite diameter (except those experiencing “irrational exuberance”). So ordinarily “capital consumers” must plan within hard constraints at the aggregate level then ration investment down to their SBUs.
Treasury’s role in a capital consumer’s planning cycle has to be as the initiator, as it usually is today. Treasury lays down the lines of maximum and optimum draw, typically to a horizon of five years, as the starting point of the Strategic Planning process. Alas, at this stage Treasury normally drops out. To create an effective interface, it must stay involved through the iterative planning process. As limited capital is distributed among the SBUs, the point is to make money, which naturally will make additional capital available to the plan.
For businesses spinning off cash, the planning process works best from bottom-up. Home Depot, for example, is so cash-positive that Treasurer Roberta Flick has the enviable responsibility of evaluating stock buy-backs against increased dividends. The Strategic Planning process for a capital producer is naturally “bottom-up”. As she said in a recent conversation, “Almost always, the best use of capital is to let our operations put it to work.”
The way a corporation plans liquid assets is similarly impacted. As I described in a previous paper on Treasury’s interface to Inventory Management (GTNews, article 5345), inventory can be described as either “financial” or “strategic”. Financial inventories have a rates-of-return that can be forecasted for any level of investment. They can be reduced as a source of capital for the strategic plan. It is not “free” money, as the cost is borne in reduced profitability, but it is available. Alternatively for companies that produce cash, financial inventories can also be viewed pure short-term investments, often with above-market returns.
Financial inventories are best managed in conjunction with Treasury’s Cash Management function. Strategic inventories, however, generally defy projected-ROI calculations. They are held to establish customer service levels, a reputation, and ultimately “market share” – which is, of course, one of the dimensions of Strategic Planning’s Growth/Share matrix. Strategic inventories are consequently more closely related to receivables in function than they are to financial inventories. Therefore the authorization for these liquid assets logically belongs in the strategic plan for each SBU. In the simplistic Growth/Share world, “stars” and perhaps “problem children” would be allocated more of these two strategic liquid assets while the ‘cows’ and ‘dogs’ get less.
When a company is basically what Wall Street calls a ‘single industry play’, Strategic Planning’s operations are quite different from those in a diversified corporation. Because there is only one “game”, the issue is not which business to focus resource upon but rather how to play the company’s industry. For example, when the Growth/Share proponents told Detroit that they should not be investing in making automobiles anymore (a “Dog”) the Big Three declined the advice and continued pouring resources into profitable factories and products – these are car companies after all.
Other factors being equal, industry concentration favors a top-down planning approach. The configuration of the proper Treasury interface follows. On the other hand, a conglomerate’s planning cycle more reasonably begins down at the SBU level and merges up. In these companies, even an engaged Treasury is tempted to hang back and wait for the composite strategic plan to emerge. Unfortunately, disengagement at the lower level guarantees “hockey-sticks” in the aggregate.
The solution is for Treasury to become the provider of forecasting expertise to the SBUs. The techniques required include both econometric and purely mathematical time-series analyses. Econometric forecasts are typically used to project an SBU’s overall market, one that includes all competing technologies doing roughly the same thing. Then either one or two market share projections are created using mathematical techniques and market research data.
In the two-step system, the first stage is a share projection of the SBU’s technology against competing technologies – foam vs. fiberglass insulation in the refrigerator market, for example. The second stage is to project the SBU’s share against other companies using the same technology. If there is only one technology, or the SBU has a lock on its own, a similar one-step process does fine. Either way, by taking over the strategic forecasting job, treasury can assure itself that the forecasts are independent from bias, optimism and intrusion from the goal-setting process for the sales force2.
Even for a company concentrated in a single industry, Treasury should be the repository of forecasting know-how. This is because, as the capital budget is deconstructed into its various geographic or demographic sub-market plays, Treasury can be consequently enabled to broadcast its risk concerns and return requirements through the Strategic Planning process down to the level at which they can be appropriately assessed and addressed. This is particularly important for global companies that have fixed-asset plays with nation-risks.
If a company is involved in extracting natural resources or distribution, its investment strategies have a wholly different flavor from those of high-tech firms whose hard-won markets can simply disappear when the “next new thing” hits the street. In technology-driven companies, there are normally a number of gates – decision nodes – that need to be traversed in the process of bringing a new product to market. DuPont’s Agricultural Chemicals division, for example, creates tens of thousands of new compounds each year, most by “analoging” around either existing products or promising but flawed chemicals. In pre-established stages, this huge number is chopped down so that at the end of the “pipeline” only a handful go to market. Software companies start with a substantially shorter initial list but proceed through basically the same step-wise process of ramping-up and weeding-out.
Each of the gates is a stage in both product development and investment. The initial bets are so small that Treasury tries not to be involved. This is a mistake. In some cases the people in the lab may be heading into a thoroughly unaffordable vision. In others, pre-knowledge of potential funding requirements for a high-potential technology could affect a host of other financial decisions. Occasionally, the best way to develop a technology is to sell it, or even the entire company. More typically, however, Treasury’s early stage involvement can ensure that return requirements are unemotionally translated into product profitability needs and, in turn, to pricing targets for testing by market research.
By far, the companies with the most highly evolved Strategy/Treasury interfaces are regulated utilities. This perhaps surprising situation – utilities are not expected to be on the leading edge of management technology development – arises from the fact that a utility’s Treasury is responsible for presenting the company’s Strategic Plan to the industry’s regulatory agency in periodic reviews of pricing, aka “rates”. These are essentially legal proceedings freighted with lawyers, witnesses, advocacy, etc.
Even in situations where the monopoly is a consequence of technology ownership, penetration is usually not a factor so forecasting is about customer-usage and market size. Investments, whether for cost-reduction or fulfillment, have some of the most wonderfully risk-free returns available in the business world.
There is perhaps no position more likely to give one a false sense of intellectual superiority than that of a monopoly’s manager. As a consequence, these people invariably want to retain earnings and use them to enter unregulated businesses. They actually believe that they could make more money if they were not “constrained” by their monopolies. Usually, their sales and profitability assumptions are ridiculous. To be sure, monopoly Treasuries are not going to breathe sanity into the process. They must protect the franchise, however, and staying close to these crazy plans allows a window on the magnitude of the mischief.
For companies that view their SBUs as an investment portfolio through which to trade, a consolidated strategic plan needs to be continuously updated, a living document, because acquisitions and divestitures do not follow any particular rhythm. In one instance, a mating dance may take years to come to fruition; in another, the company may be able to fly in as a white knight in weeks.
However these deals proceed, Treasury will always be in the thick of it. The necessary link is to tie the financial implications of each proposed acquisition or divestiture back to the Strategic Plan so the overall implications may be contained.
Large corporations need to develop better inter-functional coordination. The link between Treasury and Strategic Planning is particularly important. Development of this capability must take place with an appreciation for the dimensions of the concept-space of the interface between the two departments.
1 (Corning and the Craft of Innovation, Graham and Shuldiner, Oxford University Press, New York, 2001))
2 For more on this see Harvard Case Study 9-182-217 (“Markham Corporation”, a fictional company invented to protect the strategic interests of the actual corporation where I developed the techniques).