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The proliferation of chief “something” officer (CxO) titles over the past decades recognizes that there’s value in having a single individual focused on a specific critical problem. A CxO position can be strategic or it can be the ultimate middle management role, with far more responsibilities than authority. Many of those handed such a title find that it’s the latter. This may be because the organization that created the title is unwilling to invest the necessary powers and portfolio of responsibilities to make it strategic – a case of institutional inertia. Or it may be that the individual given the CxO title doesn’t have the skills or temperament to be a “chief” in a strategic sense.
In business, becoming a chief anything means leaving behind most of the hands-on specific skills that made one successful enough to receive the promotion. This is often the hardest requirement, especially for those coming from an administrative or a highly technical part of a business. Take the chief financial officer position. The person who gets that job often was a controller – an individual who must be able to manage the minutiae of a finance organization. Most of the detailed skills required of a great controller are counterproductive for a CFO, who must focus on the big picture, work well with all parts of the business and be the face of the company to bankers and investors. People who can’t leave the details behind are by definition not strategic CFO material. Similarly, the job of the chief information officer ultimately is not about coding, technical knowledge or project management. It’s about understanding and communicating how the most important issues facing the business can be addressed with technology, ensuring that the IT organization understands the needs of the business and delivering value for the money spent on IT.
The same distinction applies to newer C-level titles. For example, since the financial crisis a few years ago, there has been a growing recognition that banks must manage risk more comprehensively. In response, a number of banks have created the position of chief risk officer or, if they already had one, have invested a broader range of responsibilities in that office. Managing risk strategically has gained importance in financial markets as rising capital requirements and increased regulation force banks to structure their asset portfolios and manage their assets more carefully to maximize their return on equity (ROE). In most banks, optimizing risk – getting the highest return at any given level of risk – and managing risk more dynamically over a credit cycle requires a strategic CRO to lead the effort. Even so, in many organizations the office of the CRO doesn’t have the weight it needs to make such a difference. Here are the most important requirements for chief risk officers who want to transform a middle management job into something more strategic.
Approach risk management as if it were a four-dimensional chessboard. Having the proverbial “seat at the table” (a hackneyed business phrase that’s shorthand for being taken seriously by the senior leadership group) means being able to bring something of value to the table. While an appreciation of the overall business and its strategy is necessary as one rises through the ranks, a purely functional position usually doesn’t require an especially deep understanding of the other parts of the business. For a chief risk officer to play more than a titular role, however, he or she must have a solid understanding of all the major operating pieces of the business on both sides of the balance sheet and a knowledge of the industry’s competitive dynamics – three dimensions of the chessboard. This is particularly important because risk is just a constraint, not the sole consideration in decision-making. That is, the role of the CRO is not simply to enforce constraints that minimize risk – it’s about optimizing risk within the context of the corporate strategy. Stiffer capital requirements are a defining characteristic of today’s banking industry, especially in the United States. Optimizing risk is a necessary condition for optimizing return on equity and the long-term success of the bank. Moreover, the role requires thinking ahead several steps and understanding the dynamics of the business – that’s the fourth dimension. A solid grasp of credit and financial market cycles is essential in leading a risk organization. The ability to use past experience to forecast the consequences of even disparate sets of actions makes the risk organization strategic.
Learn another language. Understanding of other parts of the business goes a long way toward being able to work more effectively, and a CRO should be to translate risk jargon into words and concepts that are relevant to specific parts of the business. It works both ways, too. Understanding the objectives, objections and concerns of other executives means being able to grasp the nuances of their questions and comments. It also helps in explaining the thinking behind the trade-offs necessary to optimize a balance sheet to achieve an optimal ROE for the level and structure of the risk. It’s also essential to be able to communicate the essence of risk management to laymen, for example, by distilling the complexities of a black-box risk strategy into an elevator pitch. All risk models are translatable into easy-to-comprehend concepts. A CRO must be able to do this and even develop an institutional shorthand within the organization that everyone understands – the functional equivalent of describing a feature film as “a car-chase buddy movie.”
Assert leadership when it’s needed. Some leaders are born, but everyone else needs to unlearn habits that detract from their effectiveness as a leader. People in risk or compliance roles may have a harder time than others because the basic skills necessary to excel in this area tend to be found in less introspective souls. Those who work in a compliance function can fall into the trap of using “the rules” as a cudgel for wielding power rather than persuading and gaining assent. Joining the senior leadership team, though, transforms the CRO from a simple enforcer to one who works with others to find solutions.
Beyond these three personal and interpersonal requirements, appropriate use of information technology – data and software – is essential to strategic risk management in banks (and other financial services companies). Successfully exploiting the advantages that can be had with advanced IT is fundamental requirement of making the role of a CRO strategic. SuccessfulCROs must weigh the make-or-break information technology issues of mastering data quality and using the right software tools.
Data is the lifeblood of risk management. The credibility of the risk organization is based on accuracy and availability of data. Bad data drives bad decisions and undermines the authority of the risk organization. As data sets proliferate, grow larger and increasingly incorporate external data feeds (not just market data but news and other unstructured data), the challenge increases. The proverbial garbage-in-garbage-out (GIGO) becomes Big GIGO, as I have written. Data quality must be built into all of the systems. Speed in handling data is essential. The pace of transactions in the financial markets and the banking industry continues to increase, and their risk systems must keep up. Our benchmark research shows that financial services has to deal with more sources of data than other industry sectors.
Yet beyond these maxims is the reality that all large financial institutions fall short in their ability to handle data. “You can have your answers fast or you can have them accurate,” is often said in jest, but it reflects the business reality that analyses often are not black-and-white – utterly reliable or completely false. They may have to be based on information that to varying degrees is incomplete, ambiguous, dated or some combination of these three. Adapting to this reality, new tools utilizing advanced analytical techniques can qualify the reliability of a bit of analysis. It’s better to get some assessment and see that it’s 33 percent reliable than to get no answer or – worse – get an answer without qualification. In most cases, it’s better to get an approximate answer now than to wait for an ironclad answer in a day or two. The decision-makers have an idea of the risk they’re taking if they act on the result, or they can take a different approach to look for a way to get an answer that is more reliable.
Software is essential to risk management and optimization. Technology can buy accuracy, speed, visibility and safety. Many banks ought to do more dynamic risk management. Analytical applications using in-memory processing can substantially reduce the time it takes to run even complex models that utilize very large data sets. This not only improves the productivity of risk analysts but it makes scenario analysis and contingency planning more accessible to those outside the risk organization. If you can run a complex, detailed model and immediately get an interactive report (one that enables you to drill back and drill around), you can have a business conversation about its implications and what to do next. If you have to wait hours or days as you might using a spreadsheet, you can’t.
Desktop spreadsheets have their uses, but in risk management the road to hell begins in cell A1. Spreadsheets are the right tool for prototyping and exploratory analysis. They are a poor choice for ongoing risk management modeling and analytics. They are error-prone, lack necessary controls and have limited dimensionality. The dangers of using spreadsheets in managing risk exposure were laid bare by the internal investigation conducted by JP Morgan, which I commented on at the time. There are many alternatives to desktop spreadsheets that are affordable and require limited training. For example, many financial applications for planning and analysis have Excel as their user interface. There are more formal tools, such as a multidimensional spreadsheet, that are relatively easy for risk modelers to use and offer superior performance and control compared to desktop spreadsheets.
Automate and centralize. Information technology delivers speed, efficiency and accuracy when manual tasks are automated. The payoff from automating routine reporting and analytics may seem trivial, but this is usually because people – especially managers – underestimate the amount of time spent as well as the routine errors that creep into manual tasks (especially if they are performed in a desktop spreadsheet). The need for automation and centralization especially applies to regulatory and legal activities, such as affirmations, attestations, signoffs and any other form of documentation. Especially in highly regulated industries such as financial services, there is no strategic value in meeting legal requirements, but there is some in doing so as efficiently as possible and limiting the potential for oversights and errors. Keeping all such documentation in a central repository and eliminating the use of email systems as a transport mechanism and repository for compliance documentation saves time of highly compensated individuals when inevitable audits and investigations occur and limits the possibility that documents cannot be found when needed.
Senior executive sponsorship is also a critical need if the chief risk officer is to be a strategic player. If the CRO has done all of the above, that’s not going to be a problem because the CRO’s objectives and the CEO’s objectives will be largely aligned. True, that’s not always a given. Some organizations will not embrace the notion that managing risk can be strategic. CROs who find themselves in an organization where their aspirations to serve a strategic role are not met should find another one that appreciates the value they can bring to the table.
Robert Kugel – SVP Research
A core objective of my research practice and agenda is to help the Office of Finance improve its performance by better utilizing information technology. As we kick off 2014, I see five initiatives that CFOs and controllers should adopt to improve their execution of core finance functions and free up time to concentrate on increasing their department’s strategic value. Finance organizations – especially those that need to improve performance – usually find it difficult to find the resources to invest in increasing their strategic value. However, any of the first three initiatives mentioned below will enable them to operate more efficiently as well as improve performance. These initiatives have been central to my focus for the past decade. The final two are relatively new and reflect the evolution of technology to enable finance departments to deliver better results. Every finance organization should adopt at least one of these five as a priority this year.
Close faster. Because the process of closing the books is similar for all corporations, it should be seen as a universal performance benchmark. Our research finds that only 38 percent of all companies with more than 100 employees complete their quarterly or half-yearly close within five to six days of the end of the quarter (which is the generally accepted performance standard), while the remaining majority take longer. And for all the discussion over the years about the need to close faster, our most recent benchmark research on the close discovered that companies on average are taking a half-day longer to complete the process than they did five years earlier. For the most part, much of this increase appears to have been among companies that were already taking more than a business week to close. I’ve written that the close is a good litmus test for the overall effectiveness of a finance department.
Our research into how companies close shows that its common for two companies with exactly the same characteristics (the same size, in the same industry, located in the same country) to demonstrate big differences in how quickly they complete their accounting cycle: Company A does it in two days while company B needs nine days to get the job done. The difference is likely to be due to some interplay of people, process, information and technology. Common issues are poor process design, overuse of spreadsheets in the process, consolidation software that no longer meets current business requirements and too little automation of repetitive tasks. Our research shows the correlation between increased automation, for example, and achieving a faster close. We found that, on average, companies that have automated the process completely close in 5.7 days compared with 9.1 days for those that have automated little or none of the process. Shortening the close is important because it enables finance organizations to provide management and financial accounting information to the rest of the company sooner, reduces overtime and frees up resources that can be put to better use. Addressing such issues in a concerted program with measurable objectives is the best way to achieve progress. Moreover, in the process of shortening the close, broader issues can be addressed at their source, improving the performance of the Office of Finance. Focusing on the root causes behind too long a close process can uncover hidden issues common to many finance processes, including poor data availability and quality, poor communications and training, and too much complexity.
Even if your company is closing its books within a business week, chances are there’s still room for improvement that can come from automating existing manual tasks. For instance, reconciliations are an activity where companies with as few as 250 employees are likely to find savings of time and money using technology to automate the process and enhance accuracy and auditability.
Master Excel. Our research shows that spreadsheets are a problem when used in any repetitive collaborative enterprise-wide task (for example, planning, forecasting, closing and managing sales operations). At the same time, spreadsheets are an essential tool in business and cannot always be replaced by other software and systems. For this reason, it’s important for finance executives to ensure that the people who are designing and using spreadsheets know what they are doing. One of the root causes of spreadsheet problems is lack of competence by those designing models and analyses. Spreadsheets’ lack of transparency easily masks poor design. Typically, people are self-trained. Although they can complete assignments, the resulting spreadsheet may be inefficient, difficult to audit and brittle (difficult to change without making major modifications) and have so many vulnerabilities to mistakes and tampering that they are disasters waiting to happen. It’s common, for example, for people to create dense and complex nested logic expressions because they don’t know how to use lookup tables. Our research found that almost half (45%) of companies provide no training and just 8 percent provide regular Excel training sessions, with the rest providing only initial training or leaving it to the individual to take the initiative. Just as armies march on their stomachs, finance organizations operate in a world of spreadsheets. It makes sense to invest in the productivity of those responsible for creating spreadsheets because that investment is likely to promote productivity as well as reduce errors and the resulting rework and other costs that go with them. Along with training, testing is useful to ensure that people have the necessary skills to create spreadsheets, but almost all companies (87%) do not test their users.
Plan – don’t just budget. I have asserted that annual budgeting should evolve into a process that’s more focused on planning the business. Many people speak of planning and budgeting as if they were the same thing, but they’re not. Budgeting is essential for control, but budgets are focused on money, not things. So while they’re good for finance departments, budgets don’t deliver much value to the rest of the company. Business planning as practiced today is a relic, a process hemmed in by obsolete conceptions of what it should be. Individual business units make plans, but they are narrowly focused and not well integrated. Our business planning research found that companywide planning efforts are not as coordinated as they could be: Just 22 percent of the participants said they can accurately measure the impact of their plan on other parts of the business. While today’s budgeting and operational planning efforts are loosely connected, the next generation of business planning closely integrates unit-level operational plans with financial planning. At the corporate level, it shifts the emphasis from financial budgeting to business planning and performance reviews that integrate both operational and financial measures. This new approach uses available information technology to enable businesses to plan faster with less effort while achieving greater accuracy and agility. The approach addresses a deep-seated issue: Our research shows that in most companies the budget is not collaborative on an ongoing basis and therefore hinders coordination as companies adapt to changing circumstances. It doesn’t enable managers to anticipate how best to adapt to those changing circumstances, so when things change, as they always do, companies lack the sort of coordination they need to make changes quickly and maximize their performance. The data from our research shows that traditional budgeting does not promote strategic and operational alignment, which winds up hurting performance. And because companies take too long to review their results and in these reviews aren’t able to immediately determine the source of variances between their plan and actual results, they do not react quickly to seize opportunities and address issues.
Adopt price optimization and profitability management. For companies that close within a week, have mastered Excel and focus more on planning than budgeting, price optimization presents a new frontier on which to improve company performance. Price and revenue optimization (PRO) is a business discipline used to create demand-based pricing; it applies market segmentation techniques to achieve strategic objectives such as increasing profitability or market share. PRO first came into wide use in the airline and hospitality industries in the 1980s as a way of maximizing returns from less flexible travelers (such as people on business trips) while minimizing unsold inventory by selling incremental seats on flights or hotel room nights at discounted prices to more discretionary buyers (typically vacationers). Today, PRO is a well-developed part of any business strategy in the travel industry and is increasingly used in others. Optimization is not maximization, since the objective of the former is to achieve the best trade-off between sometimes mutually exclusive goals and their constraints. Focusing solely on profit maximization may result in wider margins but lower sales and profits, for example. Optimizing price means using analytics to gain a better understanding of customers’ price sensitivity in order to achieve the best mix of price and volume consistent with the company’s strategy. This allows businesses to achieve the highest possible margins consistent with their volume and mix objectives. Analytical software is available that enables companies to implement and manage a PRO strategy, which I covered in an earlier perspective.
Manage taxes more effectively. Corporations’ largest tax outlays fall into two main categories, indirect and direct. Indirect taxes are those collected by an intermediary such as a retailer or wholesaler and then paid to government entities. This includes sales and use tax (in the United States), goods and services tax (in Canada) and value-added tax (in Europe and other regions). A large percentage of midsize and larger corporations in North America use software to manage their indirect taxes. In the U.S., such indirect taxes are difficult to handle because of the complex and overlapping tax jurisdictions, changes in rates as well as the definitions of what’s taxable at which rates. The issue is not just calculating the amounts at the time of the transaction, but also being able to mount an audit defense as inexpensively as possible at some point in the future. If your company is not using a third party to manage its indirect tax calculations, 2014 would be a great year to start, especially if your business operates in areas where the tax authorities are most aggressive. Direct – or income – taxes are another matter. Because of their size and complexity, many midsize and almost all larger organizations need to automate more of their tax provisioning process using dedicated software rather than spreadsheets. Corporations that operate in multiple income tax jurisdictions with only moderate complexity in their corporate structure can save considerable amounts of time, have better insight into their tax positions and improve their audit defense posture by switching from spreadsheets.
Senior finance executives often spend time fighting fires rather than addressing their root causes to prevent new ones. Companies that take more than one business week to close must determine why it’s taking them so long and address those issues. The same causes behind a longer-than-necessary close are likely to be at work in all or most finance processes. Further, providing employees with Excel training and testing will improve their productivity and the quality of work they perform. And if nothing else, taking a fresh look at planning and budgeting can identify ways to streamline the process, freeing up time to invest in efforts that will improve the department’s performance. Finally, finance departments that already operate efficiently should focus on ways to play a more strategic role in their company’s business, particularly by managing pricing analytics and improving their tax provisioning acumen.
Robert Kugel – SVP Research