Thursday, May 08, 2008

Downturn finance

Economic downturns can make the lives of financial managers hellish. Paradoxically, the steps financial managers take to overcome them probably make downturns worse.

As it turns out, financial managers’ instincts about downturns too often lead them to take almost precisely the wrong steps. Most firms view downturns as times to preserve their main strategic assumptions. They waste a lot of top talent time and energy trying to squeeze extra drops of margin from every operating process. And they become even more conservative about rewarding managers strictly for results.

Plain common sense, as well as years of experience with learning processes like continuous improvement and quality control, suggests we should be doing just the opposite. Consider each of these three steps in turn.

A firm’s key strategic assumptions – often made tacitly – are probably off target even in the best of times. They’re almost surely wrong for difficult environments since unpredictability is what generally makes environments difficult. So it’s perverse, if understandable, that firms become especially reluctant to tinker with their business models during downturns.

Financial managers’ instincts lead them to try to pinch every customer-facing process for incremental revenue – and every operating process for incremental cost savings. Every change in an established process can have unforeseen repercussions elsewhere in the business, however.
So finance teams end up setting multiple fires throughout their companies’ business systems for the sake of incremental benefits that they’ll probably consume in putting out the fires.

Most firms also tend to link pay more strictly to results in a downturn. It’s not clear, though, that results are more important in downturns than at any other time. What’s clear is that results are likely to decline. So companies drive out their top talent when they need it most.

Take airlines as an example. The point-to-point routes business travelers prefer are likely to remain popular through a downturn. The trips through multiple hubs that vacation travelers tolerate are more likely to dry up. And yet downturns, for some reason, seem to be the least likely time that airlines reconsider their basic route strategies.

Instead, they focus on cost cutting, which tempts them to channel more traffic through hubs. The resulting barrage of coordinated arrivals and departures stresses out staff – just as they’re raising the variability of compensation. So the best service managers change careers.

Fortunately, there is a much better way for CFOs, controllers, and treasurers to handle downturns. The challenge is that their instincts don’t necessarily lead them down the right path.

First, since the strategic assumptions on which the business rests may well be flawed, downturns actually are the perfect time to question those assumptions systematically. Finance executives can ask top managers to lay out alternative assumptions focusing on the issues that have always bothered them – but they haven’t had time to investigate.

Second, since incremental process changes often create as many immediate problems as they solve, downturns are a strange time to try to squeeze more out of them all at once. It makes more sense to focus top managers on a few key strategic bets – corresponding to the new assumptions they are testing – and keep as many standard processes intact as possible.

Third, since paying more strictly for results as they are declining will drive out the best people, firms should pay for something more useful in a downturn. Finance executives can adjust compensation to reward the truly valuable new insights into business models that top managers extract from the strategic bets they are pursuing.

In other words, finance executives should ask division heads and general managers three new questions. What might be wrong with your business model – as opposed to your operating processes? What big bets are worth making to find out? And what can we learn from any missed goals?

This, for example, is how Toyota has come to apply its “plan, do, check, act” learning loop adapted from the work of Edward Deming. Toyota rightly treats every quarter as a potential downturn. Possibly as a result, the company doesn’t seem to suffer so badly in the real ones.

David Apgar is the author of "Relevance: Hitting Your Goals by Knowing What Matters" (Jossey-Bass 2008)

Labels: , , , , , ,


Post a Comment

<< Home