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Can finance departments be cost-effective and smart at the same time?
Don Durfee, CFO Magazine
November 1, 2005
In the decade-long marathon known as "finance transformation," CFOs have been chasing two goals. One is efficiency: the routine work of finance — from paying vendors to making reconciliations — should be done centrally and cheaply. The other is business analysis: the finance professionals who work in the business units ought to spend their time helping managers think about how to make money.
When a company attains both goals, the results can be spectacular. Consider the experience of Agilent Technologies Inc. Three years ago, the Palo Alto, California-based scientific-equipment maker was in a deep post-dot-com slump. Orders for its high-tech products had dropped 60 percent in just nine months. The company was losing hundreds of millions of dollars annually. The finance function wasn't in much better shape: some processes were inconsistent, and employees were frequently too busy finding, reconciling, reworking, or inputting numbers to help with important business decisions.
Agilent brought in a new CFO, Adrian Dillon, and gave him a mandate to overhaul finance. Dillon pushed to simplify and standardize finance processes across the company and, where appropriate, move them to offshore shared-services centers. These steps cut the cost of finance by 50 percent. He also changed the way finance supports the business, dedicating analysts to each division. These analysts have helped business managers reach decisions about which businesses to sell and which operations to relocate.
"Our company has had to make very fast decisions such as whether to shift operations from, say, Western Europe to Malaysia," says Dillon. "Those kinds of decisions are all now cosponsored by the finance team along with the general managers. In the past, finance would have never been involved."
Agilent's transformation is far easier to describe than to replicate. The trouble is that attaining the two goals requires two very different efforts. One is to wrench back-office processes away from business units to gain economies of scale. The other is to dispatch finance employees out to the business to play the unfamiliar role of strategic adviser.
Failure in the first effort could be a career ender. "Whenever you go through one of these consolidations, everyone fights you," says Greg Hackett, founder of The Hackett Group and now president of MergerShop, a Bath, Ohio-based advisory firm. "And often the person who tries to force it dies on the road to implementation."
Those who survive the consolidation find they may have won only a partial victory: cost savings for finance but little real value for the business. Indeed, while the cost of finance since the early 1990s has fallen from 1.9 percent of revenues to 1.26 percent today, the proportion of time finance employees spend advising the businesses has barely budged. (It remains just under half.) In other words, many finance functions are more efficient than smart.
How should CFOs go about creating a finance operation that is both? Now is a good time to ask the question. According to a new study by The Hackett Group, companies are still rushing to centralize as many finance processes as they can, including activities that many regard as the purview of business units, such as budgeting and planning. Twenty-seven percent of finance processes on average are performed in the business units today; three years from now, companies expect that number will drop to 11 percent. "There's no question — we are still moving very quickly toward centralization," says Rick Roth, chief research officer of The Hackett Group.
At the same time, most companies face an ever-growing list of competitive threats. They can't afford a finance operation that is merely inexpensive.
An Echo of the Past
There is a good reason why finance transformation is proving to be an uphill fight at many companies. By attempting to consolidate finance processes, CFOs are moving in exactly the opposite direction from the rest of their companies, which are generally becoming more decentralized.
Until about 20 years ago, most businesses and their supporting functions were highly centralized, a legacy of the command-and-control model popular since the days of Henry Ford. Then, beginning in the late 1980s, managers discovered that with the help of new technologies such as E-mail, they could radically decentralize their businesses and dramatically improve business performance. "Companies are finding that in our knowledge-based and innovation-driven economy, the factors for business success are the same as the benefits of decentralization: motivation, flexibility, and innovation," says Thomas Malone, a professor at the Massachusetts Institute of Technology Sloan School of Management and the author of The Future of Work.
Finance dispersed along with the business units. That wasn't an accident. "The one word business managers were used to hearing from people who did accounting at the corporate level was 'no,'" comments Hackett. "So people said, 'I'm tired of this — I'm responsible for this business unit and will make the investments in it.' So they hired their own finance staff."
Such duplication wasn't cheap. CFOs found that not only were they spending more on finance, they lacked visibility into the various operations of the business. This time, the solution was shared services. Pull routine finance processes away from the businesses, make them the same, and do it in one place, and you would create immediate savings — typically 15 percent. (Additional savings were possible through improving the process and adding technology.)
Today, the Sarbanes-Oxley Act is providing an extra nudge for adopting shared services. "Companies are finding that if you have your key controls in one place as opposed to 300, it is much easier to comply with [Sarbox]," says Gary Moran, managing director of Alvarez & Marsal in New York. In fact, companies with a high use of shared services spend 33 percent less on compliance, according to The Hackett Group. (But some argue there are better means to the same end; see "Kill Your Shared-Services Centers?" at the end of this article.)
Obviously, finance departments aren't trying to stage a return to the days of the Eisenhower Administration. This time, the idea is to separate the routine work from the "value-added" work, centralize the former, and decentralize the latter. Technology helps by giving business units easy access to centralized information.
But the change still means pushing a certain amount of centralization on an organization that is headed the other way. And just as business managers complained 15 years ago that corporate finance was an obstacle, there is still concern that relinquishing control of even routine processes could create problems. "If you are a business-unit head and you control all parts of the transactional finance process, then you feel issues with suppliers or customers will be resolved with a greater sense of urgency," says Eric Olsen, CFO of Lafarge North America, a $4 billion construction-materials company. "You know you won't have a supplier yelling at you to pay your bill."
The challenge can be great for a large, entrepreneurial company. Consider the case of AutoNation Inc., a $19 billion auto retailer that began as an agglomeration of 275 existing auto dealerships. "We aren't like Home Depot, where you build on a greensite and replicate the model over and over," says executive vice president and CFO Craig Monaghan. "Instead, we inherited 275 unique computer systems, 275 charts of accounts, and 275 cultures."
Monaghan has been working to impose some order. So far, one-third of the company's stores are doing some of their basic accounting in AutoNation's shared-services facility. Twenty stores have shifted over entirely. Monaghan predicts the project will take another two to three years. "This is not easy," he says. "It's naïve to think that when you do this, you're just changing the finance organization. As we change our back-office activities, we inevitably force the front end of the business to change as well. For example, the way you sell a customer a car and help the customer get financing is unique to every store today, but will have to move to a national standard. And there's the rub: everyone thinks their way is best."
Such beliefs often contain some truth. While there's little reason to have hundreds of different accounts-payable processes around the company, there can be subtle — but important — differences in what businesses need from that activity. For example, if one business unit is focused mainly on cash flow, it may be more concerned with the cycle time of the collections process than with its cost. For another unit, the concern might be around error rates, because its customers have been upset in the past about incorrect bills.
Dillon of Agilent Technologies agrees that a shared-services operation that is out of touch with the specific needs of its customers can create problems. Agilent's solution has been to encourage both shared-services and business-finance employees to do rotations within the businesses they serve. "In the area of cost accounting, for example, it's true that you are going to learn better when you are on the shop floor than if you are in Bangalore," says Dillon. "By aligning employees in our shared-services center to that business and offering rotational assignments, we get some good cross-fertilization."
What is difficult for basic accounting is even harder for higher-level processes such as management reporting and budgeting, planning, and forecasting. Dow Chemical is one company that centralizes all of these processes. According to corporate vice president and controller Frank H. Brod, planning activities are managed by the corporate finance function, which determines what global assumptions (such as currency rates) the entire company will use. A six-person "shared reporting team" works with the company's four business finance directors to come up with the plan. Business-unit executives contribute to the process.
This works for Dow, which has arranged its hundreds of businesses into just a handful of portfolios, but other companies will prefer to leave more of the process in the hands of the businesses. "I'd be very concerned about centralizing an activity like forecasting," says Lafarge's Olsen. "With our 1,000-plus operating sites, we would lose the touch and feel of where those businesses are going."
The Human Element
With the right mix of planning, persuasion, and browbeating, many CFOs will manage to consolidate finance processes. But the real question is whether they can deliver on the ultimate promise of consolidation: that transactions will become so routine that finance can devote more effort to helping managers ponder business decisions.
"If you centralize finance activities and manage only to cut costs, then I think you are missing the bigger part of the opportunity — to provide support for growth," comments Rich de Moll, vice president of finance transformation for Capgemini U.S. LLC.
Making that happen means clearing several hurdles. One is providing the technology that gives analysts easy access to all of the data generated by the shared-services operations. Several years ago, Dow moved all of its 450 business entities onto a single ERP system and added performance-management software to let local finance employees troll through the data on their own. "Since we use one database, you get the same answer no matter where you're looking from," comments Brod.
Technology alone isn't enough, of course; think of the expensive ERP implementations of the 1990s that failed to make businesses more effective. "A lot of people say, 'We're going to spend more on data,'" says Kurt Reisenberg, executive director of the CFO Executive Board. "But what their business units really need is good business advice and insight into the data — and that requires the human element."
Unfortunately, finance departments often don't have the people with the right skills. CFOs who have built strong decision-support operations have needed to hire new employees. This was true for Cisco Systems Inc. "Without the right people, finance transformation is just not going to happen," says Dennis Powell, CFO of the San Jose, California-based networking giant. "As you look at people, you need to ask, 'Can they think strategically? Can they work across functional boundaries? And do they have the intellectual curiosity that will drive them to learn as much as possible about the business?'"
To foster a closer bond between finance and the business, Powell has established a program to rotate finance employees throughout different parts of the company. In the past year alone, 30 percent of the finance department spent time working in other roles. "Some of them return to finance and some stay in operations," says Powell. "Either way is OK with us. It means we have very financially astute people working in the business as well." (See "Decision Support at Cisco" at the end of this article.)
Once finance has the right people, the CFO must be committed to placing some of the best ones in the business units. "One way for centralization to go wrong is to take all of the good decision makers and put them in an insular bureaucracy," says Frank Galioto, a vice president at Booz Allen Hamilton. "What you want is to have the more senior people close to the business and the more basic stuff in shared services."
Finally, companies need the right reporting relationships for finance. Sarbox has brought a general tightening of the bond between business-unit finance operations and the CFO, says Alvarez & Marsal's Moran. "CFOs want their business finance employees to feel more pressure to report what's happening in the business up to the finance organization." The danger is that this may undermine the close relationship between operational heads and their finance teams.
But the shift to solid lines will probably be short-lived. Ron Foster, formerly CFO of JDS Uniphase and Novell and now CFO of FormFactor Inc., a Livermore, California-based technology company, argues that as compliance becomes routine, the link between local and central finance will naturally revert to a weaker form. "I've found that in companies with more-mature finance processes, you don't need the solid line to the CFO," says Foster. "As the financial controls of Section 404 become embedded in operational controls, you can let operations own the relationship to business finance."
Indeed, if long-running finance department transformations work as planned, then centralization will be just a detour on the way to more-dispersed, entrepreneurial companies. "We're seeing a sea change in how businesses will be organized," comments Malone of MIT. "In the short term, you will see backs and forths because of factors like Sarbanes-Oxley. But those are like waves across the surface of the ocean. The move to decentralization is like the changing tide."
The CFO's challenge is to move with the tide — without letting finance operations drift out to sea.
Don Durfee is research editor at CFO.
Kill Your Shared-Services Centers?
"Any company trying to consolidate finance today is wasting its time." The words of a disgruntled operations executive? Hardly: that remark comes from Greg Hackett, a management consultant whose pioneering benchmark studies of the finance function helped launch the shared-services movement in the 1990s.
Hackett's contention, in a nutshell, is that technology and outsourcing have together made shared services obsolete. "Shared services were a way of standardizing your finance activities so that you could deploy best practices," he says. "Then enterprise systems came along, and you could use that as a surrogate function to force people to change. But now the answer is to just outsource the whole thing.
"Ten years ago I would have told you the opposite," says Hackett. "Back then, the outsourcers had big problems: they were usually higher cost, and the technology wasn't there to help them integrate with your systems. But all of that happens today. The best outsourcers are now equipped to take your messy processes and make sense of them. You don't have to negotiate internally about what the best practices are — the outsourcers have built the best practices into their technology. And because your finance employees will now work for the outsourcers, you'll find that the internal politics get truncated quickly."
What about the argument that some large companies — because of their scale — can process transactions even more cheaply than the outsourcers? "If you think you can do it cheaper, you probably aren't looking at total cost, including the cost of overhead and periodically upgrading technology," says Hackett. "As a rule of thumb, unless you can do it a third cheaper than the outsourcer, you are lying to yourself."
Similarly, Hackett argues that finance shouldn't be in the business of generating management reports. Instead, those should be automated with off-the-shelf software.
The reason to be rid of all this work is that finance has bigger issues to worry about. "Today, there are so many things coming at companies that you need to be on the front line helping business leaders assess their risks and opportunities," says Hackett. "But you can only do that once you purge the mind-set that transaction processing is actually part of finance. It's just cutting checks, and people have been doing that since the 14th century. It's time to let go." — D.D.
Decision Support at Cisco
If there were a prize for the most discussed but least implemented management idea, "business partnering" would be a strong contender. CFOs have been talking for years about the need for finance to work with business managers on strategy and operational issues. But to date, only a relative handful of companies really do it.
Cisco Systems Inc. is one. For many years, the company has dedicated teams of financial analysts to each of its businesses. Because routine transaction processing is centralized and largely automatic, these analysts have been able to focus on delivering data and analysis to business managers. But until recently, says CFO Dennis Powell, they spent too much of their time on the data part. "In the past, we had people writing their own programs to get specific numbers," he says. "Now, we're pushing more of the data out to the businesses."
To do this, finance helped managers think through what metrics they need to run their businesses — measures such as growth, profit, market share, and customer satisfaction — and send that data from a central database to each executive's dashboard. The users can drill down for specifics, but simplicity is the goal. "We want to give a straightforward and brief view that allows the manager to keep a finger on the pulse of the business," says Powell.
Largely freed from the search for numbers (analysts still have to dig for about 5 percent of the data that businesses need), finance analysts are spending more time on strategy development. Powell identifies four ways finance helps. Value chain analysis is one. This means finding the most profitable links in a chain of activities, so the company can decide where to focus its efforts. For example, finance was involved in Cisco's early decision to outsource all of its manufacturing. Risk analysis is another. Finance maps the risks of alternate strategies and, once the business has settled on a strategy, sets up a system to monitor threats and give early warning of any problems.
The third way is competitive analysis — assessing the strengths and weaknesses of the companies Cisco would run up against in any strategy. Finally, finance helps link strategy to execution by defining the metrics that will reveal whether or not the plan is working.
Beyond this, finance helps in areas such as operational efficiency. Two years ago, Powell led a drive to cut Cisco's operational costs from 41 percent of revenues to a goal of 35 percent. Finance built the case for doing so, then developed, monitored, and managed a cost-cutting program for each organization. In eight quarters, operational costs have fallen to 36 percent. — D.D.