Middle Managers’ Poor Decisions Slash Profits

Having finance team members support business unit stakeholders drains EBITDA, says Gartner; instead, align them with specific types of decisions to...
David McCannDecember 21, 2018
Middle Managers’ Poor Decisions Slash Profits

Poor operational decisions by mid-level managers are extremely common and can erode profit margins by several percentage points, according to a Gartner report released on Thursday.

CFOs seeking to better support these managers should redefine the roles of their finance business partners — those assigned to support decisions by business unit managers — to more specialized positions focused on individual decision types, according to Gartner.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

“Managers tell us that they have faced a significantly higher volume of financial decisions over the past three years,” says the report’s author, Gartner research vice president Randeep Rathindran. “This increased volume has exposed the lack of rigor employed by most mid-level managers in reaching material decisions that impact the bottom line.”

In a global survey across various industries, Gartner asked 468 business decision-makers (i.e., middle managers) about their operational decisions. Also participating in the survey were 128 senior finance executives. More than 6 in 10 (61%) of the business respondents noted an increase in operational decision volume, while 57% indicate that these types of decisions materially impact business profitability.

Moreover, the mid-level managers reported a growing volume of decisions with material business impact are being made with a high rate of exceptions to operational decision rules put in place by finance (see chart).

The analysis also revealed that many business managers responsible for making such exceptions are operating in a vacuum. In fact, 22% of them said they don’t consider a single financial implication when making such a decision.

Such laxity can contribute to a $5 billion revenue company sacrificing upward of 3% of earnings, given the thousands of material business decisions it faces each year, according to Gartner.

In order to estimate the profits sacrificed by poor decision making, Gartner asked business decision makers:

  1. How many decisions they make in each of seven operational categories — pricing, capacity utilization, marketing campaigns, product/service improvements, vendor selection and contracting, non-price promotions, and inventory management.
  2. What is the approximate profit at stake per decision?
  3. What percentage of decisions don’t adhere to business rules, employing an assumption that exception-based decisions tend to be financially unsound.

Gartner then multiplied 1x2x3 to get the total profits sacrificed.

The research determined that most companies make a lot of costly operational mistakes. For example, the business managers of one $5 billion company, with a 21% EBITDA margin, told Gartner that each year it likely makes:

  1. About 400 to 900 decisions about capacity utilization (which equipment to shut down or which to run into overtime, for example). Each decision puts anywhere from $15,000 to $50,000 in profits at stake. Unsound decisions are estimated to wipe out roughly $8.3 million of EBITDA.
  2. About 400 to 700 decisions by sales teams to adjust contract pricing, risking $20,000 to $50,000 per deal and potentially erasing more than $7.4 million of EBITDA.

So, poor decisions of just those two types could pare the company’s EBITDA by roughly 1.5%. Add in other types of decisions — product/service improvements, vendor selection and contracting, new marketing campaigns, non-price promotions, inventory management — and the EBITDA toll could reach past 3%.

The current model of finance team members aligning to specific business stakeholders “lacks the level of expertise needed to provide support on the specific decision types faced by mid-level managers,” says Rathindran. “Unfortunately, 77% of companies we surveyed are still aligned to the stakeholder-based model.”

In order to plug the leakage of margin and profits associated with poor financial decisions, Rathindran outlined a new model that provides managers with support tailored to specific types of financial decisions they encounter.

According to Rathindran, the transformation to a decision-expert model can be phased in with as little as 20% of a company’s financial planning and analysis team. It requires no additional placement of finance team members with business units compared with a traditional approach.

“Focusing on changing behaviors of finance business partners is the most effective and fastest route to providing the type of support managers need to make effective financial decisions,” he says. “Finance departments can start small and see an immediate impact.”

Over time, he adds, they can “more than double” their effectiveness.