How to ensure your central finance
function is adding value, not creating
bureaucracy
Is your finance function helping build the business, or merely bogging it down
in bureaucracy? Andrew Campbell describes a challenge process for ensuring
your central finance function adds value
Andrew Campbell is director Ashridge Strategic Management Centre and the
author of 10 books on strategy and organisation, including the classic text
‘Corporate Level Strategy’
“I am from head office and I am here to help” is a common joke. This is
because head office functions are so frequently either unhelpfully bossy or
bureaucratic or both. Most central functions are seen as a source of extra work,
rather than extra help.
Finance is an example. Managers in business units frequently complain that
group finance makes endless information requests, but never gives anything of
value back. If not asking for information, group finance is felt to be imposing
policies and processes that often seem inappropriate when implemented in the
local situation. So how can CFOs make sure that their central finance team is a
source of added value rather than bureaucracy?
The answer is that CFOs should set up a process to rigorously challenge every
activity that is centralised and every plan to increase centralisation. The
objective is not principally to reduce the amount of centralisation, although
sometimes this is the result. The main aim is to make sure that centralised
activities are focused on adding something important to the success of the
company. In other words, the objective is to avoid policies, processes or
functions that are bureaucratic or self-serving.
The necessary challenge process for achieving this objective should involve the
following three questions. If the answer to the first question is no, ask the next
one. If the answer to the second is no, ask the third. And if the answer to the
third question is no, abandon the activity – since it will almost certainly be a
source of time wasting and bureaucracy
1
1. Is the activity non-discretionary?
The first challenge is to ask whether performance of the activity involves any
choice. Does this activity have to be done because of legal or stakeholder
requirements or as part of basic controls? Also, if it does have to be done, does
it have to be done at the group centre? For example, the annual report and
accounts and related filings are required by law. Moreover, it is impossible for
this task to be delegated to the business divisions. It must be done in the group
centre.
In contrast a system for budgeting and financial forecasting is discretionary: it
is not required by law or by external stakeholders. While it is a common feature
of most companies, there are successful companies, such as Virgin Group and
most private equity firms, without central budgeting processes: each business
division has its own process.
Also some essential activities, do not have to be centralized. For example,
significant investment decisions need to be supported by a business case. This
is an essential part of the control system. But the business case does not have
to be developed by a central finance team. Business divisions can do their own
business analysis.
Non-discretionary items that must be carried out at the centre need no
further challenge. They may feel bureaucratic to the business divisions. They
may even be time wasting. However, since they are required, further debate is
unhelpful. The CFO needs to benchmark these activities against other
companies to make sure they are executed efficiently; but he or she does not
need to challenge them further
2. Is the activity designed to add (or help add) significant value?
For those activities that are discretionary (i.e. the answer to question 1 is “No”),
the next challenge is about adding significant value. If the activity is designed to
add significant value, it does not matter if it takes up the time of managers in
the business divisions or distracts them from other priorities. The gain is likely
to be large enough to justify the pain. Of course it makes sense to execute
these activities efficiently. But, they are unlikely to be a source of bureaucracy
or time wasting.
So what constitutes significant added value? We have found that 10% is a
practical hurdle: will the activity add 10% to the market capitalisation of the
group or to the overall profits? If not, and as you might expect, most finance
activities do not meet the 10% test, then it is reasonable to ask “is the activity a
necessary part of some larger initiative that will add 10% to the market
capitalisation of the group?”
Why is 10% a reasonable hurdle for this test? First, from practical experience
10% appears to limit the significant central initiatives to a manageable number
of between three and seven. Second, each significant initiative takes up some of
the organisation’s scarcest resource – top management time. If the initiative is
2
not aiming for at least 10% improvement, the opportunity cost of the senior
management time may well exceed the benefits of the initiative.
Consider a typical finance initiative: standardising on SAP enterprise software
across the company. If the finance team can argue convincingly that the project
will lead to a 10% increase in profits through cost reduction or additional
revenues, then it makes sense. If not, the project fails this hurdle and should be
tested against the third and final question (see below).
As already mentioned, some finance activities do not meet the 10% hurdle on
their own, but may be an important supporting activity to an initiative that does
meet the hurdle. For example, performance management can be a major source
of added value. Stretch targets and tight performance monitoring can often
squeeze out an additional 10%. Finance may not be leading the performance
management effort, but is likely to be providing vital support. Finance may
provide the numbers and suggest suitable targets (in fact a common SAP system
may help with this). Finance will help spot variances and suggest ways of
getting back on track. Finance may even be the keeper of the list of ‘to dos’,
and check them off as each is completed. None of these activities on its own
adds 10%, but, as part of a performance management system, together they
would pass this hurdle.
Unfortunately, most groups do not have a clear list of their main sources of
group added value (for an example of such a list see the box ’The group added
value of a global logistics company’). This can make it hard for the CFO to judge
whether central activities such as the budgeting process or the process for
monitoring variances or the M&A unit are part of larger initiatives that generate
10% improvements. If there is no list, the CFO will need to propose his or her
own list of major sources of group added value and how group finance links to
them. Without a list of the significant sources of group added value, there is
little focus for any of the group functions. So raising the issue with the CEO and
executive colleagues can provide clarity for more than just finance.
3. Is the activity a minor source of added value AND set up to ensure
low risk of negative side effects?
There are many areas where economies of scale or skill suggest that
centralisation is likely to deliver lower costs or higher quality, but the benefits do
not amount to a 10% improvement. For example, centralising payroll in a large
company may save some millions of dollars of administrative costs, but it will
not improve the market value of the company by 10%. In the same way,
centralising credit assessments of suppliers is likely to lower the cost of making
the assessments and improve the average judgment. But, is unlikely to add 10%
to profits.
Be wary of these minor sources of added value that do not pass the 10% test.
They are often the major source of bureaucracy and time wasting. Because the
added value they bring is small, they will probably distract senior managers
from more important activities. Alternatively, if they are left to junior managers,
they can become inefficient or overly complex, and they can result in frustration
3
within the business units, as more and more activities are stripped away from
business unit control.
So minor sources of added value should be pursued only if the risks of
bureaucracy, inefficiency, distraction and de-motivation can be kept to a
minimum. This is where a CFO’s influence can be most powerful in finding the
right balance between centralisation and decentralisation.
The CFO should say “no” to these minor sources of added value activities,
unless he or she is convinced that the initiative has been designed so that the
risks of negative side effects are low.
Take the idea of a central credit assessment team. The risk of negative side
effects would be low if the team was to be led by someone with a track record
for efficient credit risk analysis; was visibly targeted on cost per assessment,
speed of service and quality of judgment; was to report to a head of shared
services (hence not take up the time of senior finance people); and had the
support of business divisions because they saw it as a burden taken from them
rather than an additional control over their freedom.
If, on the other hand, the proposed head of the team did not have a strong
track record, the KPIs for the unit had not been specified and the CFO was likely
to have to invest time in soothing the concerns of business unit leaders and
monitoring the performance of the new unit – then the risks would be high and
the CFO should say “no”. It is better to leave some value on the table, than set
up an activity that risks doing more harm than good.
Conclusion – Why effective challenge is so important
The reason why the described challenge process is so important is because
group functions are often sources of negative rather than positive performance.
Moreover, group strategy frequently fails to give clear guidance to those group
functions about what their agenda should be. The group strategy may define
priorities in terms of segments and geographies and technologies. But it rarely
defines priorities in terms of centralisation or added value. This means that
CFOs get only a limited briefing either from their boss or from the executive
committee about how far they should centralise. They normally develop their
own agenda, propose it to the CEO and the executive committee and judge what
to do based on the responses they get. So they need a process for challenging
their own thinking, because they frequently do not get enough challenge from
their bosses.
Strong challenge is particularly important in the current environment, when
many companies are looking for extra cost savings and controls. At times when
centralization is on the agenda, it is easy for the pendulum to swing too far.
Hence, right now, CFOs need a powerful way of deciding what to centralise and
what to leave in the business units.
The three questions provide the framework. Judgment is still required. But, by
asking the three questions, CFOs will be teaching their functions how to add
value without creating bureaucracy or resistance from business units.
4
Finance role in major sources of group added value in a global logistics company
A. Guidance on investments, business models and contract terms
- Finance role – check business cases, develop financial models,
provide analysis support to business units
B. Coordination of business unit relationships with major customers
- Finance role - calculate profitability by customer across all business
lines
C. Coordinate of business unit activities in selected less-developed countries
- Finance role - none
D. Centralisation of selected specialized operating activities, such as aviation
- Finance role - provide finance business partners and accounting
services
E. Efficient financial and tax structure
- Finance role - lead the development of efficient tax and balance
sheet structures
How to identify the activities to stop
5