investiledysfunction

In this recent interview from Business Finance Magazine’s Sept 2009 issue entitled, “The Serial Transformer“, Gary Crittenden, CFO of Citigroup, talks about his efforts to transform the finance organization at Citi.

He touches on many critical points about Finance Transformation which we help organizations with including corporate portfolio management (Investment Optimization), reengineering and driver-based planning.  Some relevant excerpts are below, but I recommend reading the entire article for those interested in creating a strategic finance organization and who are looking for ideas and a high-level gameplan from somebody who has successfully done this before in other organizations.

Gary led such a transformation for American Express Finance which transformed the organization into one of the most respected and strategic finance groups in a large organization.  American Express Finance has been discussed and chronicled by the Harvard Business Review, CFO Magazine, and the CFO Executive Board to name a few.

(shameless plug: Gary also wrote the foreword to my book - more info here)

Here are a couple of noteworthy excerpts:

On Selecting the Best Projects and Investments Using Investment Optimization

“…We think very carefully about every dollar that gets added back that offsets the reengineering.

This process is called investment optimization. We go through and look at the expense dollar optimization and ensure that we have a common definition for expenses across the company. I’m talking about the end-state now — not where we are, but where we’re headed.

In a company that is this large and this complex, even getting the definitions common is important so that somebody who is making an investment in a fixed income trader in, say, Brazil has the same financial metrics, terminal value, and present value calculations.

This is a big part of what has to happen as part of this process. But once you have this, you can then align those opportunities and say which one you prefer. You also know what’s on the margin — what the 20 last things were that I approved that would have the least impact if I had to cut them. You also know what the 20 next things are that you would approve if you had some dollars. And if you’re constantly updating and reforecasting, then you’re always able to ask yourself the question, “Do I need to cut or can I have the opportunity to add?”

On Driver-Based and Rolling Forecasting

“It ties back into this primary thing, which is that we’re trying to drive the performance of the business. There are several different elements to it.

One is to have a rolling forecasting process so that you’re always looking further ahead than you normally would. The way this starts for us is with a strategic plan that looks at a couple of years. This then turns into an annual plan, and then the annual plan gets refreshed each quarter, out for that quarter plus then the additional six months on the end of that, and then we update this twice a month as part of our normal process.

We’re always looking forward and doing a normal update to this. Now, if you’re going to be updating this frequently, you can’t do it from a bottom-up basis. You quickly conclude that you have to use the primary drivers of the business as opposed to the detailed, kind of bottom-up forecasting. It turns out, paradoxically, that doing this is just as accurate as the bottom-up forecasting. In fact, you probably get more accurate data because you’re doing it a lot more frequently.”

We do lots of work in the financial services industry and so we tend to look at what the sell side is saying about public companies we work with.

From past lives, we even know some of the guys on a social basis and will occassionally shoot the breeze with them.  Overall, they tend to be smart, driven and very good with Excel.  These are all essential ingredients for a good time.

But like the internet days when we had superstar analysts (Henry Blodget anyone?), we now have the new market guru of the financials arena in Meredith Whitney of Oppenheimer & Co.

She’s undoubtedly made some prescient calls and hasn’t been shy in making them aggressively and in an outspoken manner, but the question really is whether Meredith Whitney is more sizzle than steak?

When you look at her performance as reported in the August 18, 2008 issue of Fortune, you get some perspective into this.  They write:

“Whitney’s insights haven’t always translated into lucrative investment picks. Based on the performance of her buy and sell recommendations relative to her industry peer group - what analyst tracker Starmine refers to as an analyst’s “industry excess return” - Whitney’s stock picking ranked 1,205th out of 1,919 equity analysts last year and 919th out of 1,917 through the first half of 2008. That said, evaluating Whitney solely on the timing of her buys and sells misses the point. It’s not just that she’s bearish on the entire banking industry. What makes Whitney so interesting is the brutality of her arguments and the evidence she summons in making them.”

Based on the statistics aka something we call the facts, Meredith Whitney isn’t that great a stockpicker.  And if I’m a client or investor, I’m guessing that the correctness of stock picks is what makes me money and not the “brutality of her arguments and the evidence she summons in making them.”  Looking at her stock picks as a metric for measurement doesn’t “miss the point”.  It is the point.

However, the media love a story and Meredith Whitney provides it.  She is married to a WWE wrestler (JBL for those like me who are former WWE fans.  And no I’m not ashamed to admit that.  Okay, I kind of am).  And more importantly, she makes swing for the fences calls which attract attention.  If she was wrong, she’d have faded into obscurity.  But because she has been right on some of these big, hairy prognostications, she’s been appointed a guru and CEOs and CFOs spend time with her (most recently Ken Lewis, CEO of Bank of America, CFO Nelson Chai of Merrilly Lynch and CEO Ken Chenault of American Express).

Unfortunately, it seems the frequency of being right which I presume the folks who are ranked highly in the equity analyst crowd are is being drowned out by the magnitude of correctness no matter how frequent.

Let’s remember the primary objective of an equity analyst should be to make good calls that inform clients’ investment actions and enable their success.  As a result of this, they should be rewarded.  Somehow, being 919 out of 1917 equity analysts doesn’t seem worthy of much praise, but once again, style sells.

The question now is if Meredith Whitney’s stock picking skills don’t improve, how long will the hype last?

Ken Chenault, the CEO of my alma mater, American Express, was one of the folks questioned in “The Three-Minute Manager” column of Fortune Magazine May 5, 2008 and was presented with the following query “My company is getting big.  How do I continue to grow without focus?”

On the topic of innovation, Chenaullt mentioned the company’s inaugural $50 million Chairman’s Innovation Fund which I set up, led and managed before leaving for Brilliont.  He specifically stated,

“We’ve set aside $50 million for an innovation fund.  People at every level can submit ideas, and the top management team selects several different projects for seed money.  We also work with our partners.  We believe very strongly that our partners can help us come up with ideas.”

AmEx was named the most innovative financial services company by Fortune for 2007 so the company’s efforts are yielding benefits.  Of particular note is that with our work on the innovation fund, we’d made sure to carve out this $50 million to ensure innovation wasn’t something we do when convenient but all of the time.  Also, the push towards getting ideas from partners also ensures the best ideas are captured from not only employees but others who have a vested interest in the company’s success.

When I talk with clients or speak at conferences about corporate portfolio management, I aim to make it clear that when we talk about portfolio management we should not only be concerned with the monolithic total organization portfolio.  Because ultimately, the company’s total portfolio of projects & investments is an amalgamation of many mini-portfolios within the organization.  These mini-portfolios are numerous and include portfolios along line of business, business segment, geographic region/country and functional lines (IT, marketing, sales, R&D, etc). 

As a result, organizations which want to be successful with corporate portfolio management should spend time optimizing each of these mini-portfolios first, then roll these up into the company-wide portfolio and then do another round of optimization on this larger corporate portfolio.

David Haigh, group chief executive of Brand Finance talked about this recently in a Knowledge at Wharton article and summarized this concept nicely.  His comments are specific to brand portfolios but the idea of mini-portfolios which he describes can be extended to project and investment portfolios.  Haigh states, “For example look at Diageo, the drinks company. You could say they’ve got 50 brands – Baileys and various others — and each one of those is a brand. They would have a profit & loss account and a balance sheet against each one of those brands. It’s really a portfolio of businesses that aggregate up to make Diageo as a whole, and the same for others like Unilever. They have a whole variety of individual brands that go as a portfolio. Unilever said a few years ago, they’ve got 1,600 brands. They wanted to get rid of 1,200 of them, and only needed 400. Those are the 400 that are going to create growth going forward. So they sold off the 1,200 brands. But what they meant is they are selling off 1,200 individual branded businesses to different people.”

Haigh also touches upon how the portfolio approach can be used to make major strategic choices about company direction.  In the case of Unilever, they sought to simplify their product portfolio and based on return and risk parameters made the decision to get rid of certain businesses. 

This is very analogous to what we’d done at American Express when we made the decision to spin off Ameriprise (formerly American Express Financial Advisors - AEFA).  Amongst other factors, we looked at the return characteristics of the AEFA mini-portfolio as compared to other AmEx businesses and saw that this mini-portfolio was better suited to being its own stand-alone company as it would have a very difficult time competing for investment and project resources against a card business with phenomenal return characteristics.  The insight here appears to have been spot on given Ameriprise’s performance after the spin-off has been quite outstanding. 

Before leaving American Express recently, I’d established and led the company’s inaugural Chairman’s Innovation Fund.  I was glad to recently see that Fortune Magazine recognized American Express as the most innovative company in the Financial Services industry.  The company’s CEO, Ken Chenault, spoke about the organization’s innovation efforts and the Chairmans’s Innovation Fund in particular.

“A difficult economic environment argues for the need to innovate more, not pull back,” says American Express CEO Ken Chenault. A few months ago he established a $50 million innovation fund to finance “employees’ ideas for how to transform our business long term. We want great ideas to come from all over the company, not just the chain of command,” Chenault says. AmEx (AXP, Fortune 500) (No. 13) has a venerable history of making risky moves during downturns. Back in 1958, despite a slumping economy, the company launched a little thing called the American Express card. “When I first came here, I saw a copy of a letter from an analyst that earnestly explained to our then chairman why the card was a terrible idea and how it would cannibalize our traveler’s check business,” says Chenault. “It was an impeccably logical argument - that couldn’t have been more wrong.”

An article that appeared on Next Generation Pharmaceuticals cited my efforts at American Express while leading their corporate portfolio management (Investment Optimization) effort.  The article goes on to talk about how what we did at AmEx would be leverageable and should be strived for in a pharmaceutical organization.  Check it out by clicking here.

I’ve spent the last bit going through an old issue of the McKinsey Quarterly hence my second post on an article from them.  This article is titled “The Granularity of Growth” and is authored by Mehrdad Baghai, Sven Smit and S. Patrick Viguerie and is in their issue #2 in 2007. 

Unlike my prior post on the McKinsey M&A article which contradicted itself, this one has an underlying premise/approach which is sound and actually quite useful.  Unfortunately, the results are completely unbelievable and 100% contrary to our own very similar research.

First, let’s discuss the portion that makes some sense - the methodology.  Revenue is disaggregated into its three components: revenue from market growth in segments in which it competes, revenue gained through M&A and the revenue gained/lost through market share gain or loss which is effectively organic growth.  So breaking up revenue into its components makes total and complete sense.  Companies spend a ton of effort understanding expenses but the revenue side is often not as carefully studied or broken down.  Their methodology is fairly sound, but I’d recommend breaking up the organic component into revenue attrition (customers who leave or who are asked to leave the franchise) and organic revenue growth (for example, revenue from new customers to the organization or gained through deepening relationships with existing customers). 

I actually utilize this method in my recent article in Business Finance Magazine entitled “The Care and Feeding of Plus-Sized Portfolios.” (To see a .pdf of the article as it appeared in the magazine, click the following link to download the article.  Download business_finance_magazine_article_anand_sanwal_corporate_portfolio_management.pdf) 

With a sound methodology in place, the authors disaggregate revenue to deliver their findings as follows:

• “A company’s growth is largely driven by market growth in the industry segments where it competes and by the revenues it gains through mergers & acquisitions”
• “These two elements explain nearly 80% of the growth differences among the companies we studied.”
• “Whether a company gains or loses market share - the third element of corporate growth - explains only 20% of the difference.”

They conclude that “executives ought to complement the traditional focus on execution and market share with more attention to where a company is - and should be - competing.”  They in the sentences prior also comment that “although good execution is essential for defending market share in fiercely contested markets and thus for capitalizing on the corporate portfolio’s full-market-growth potential, it is usually not the key differentiator between companies that are growing quickly and those that are growing too slowly.”

Here is where I disagree quite vehemently.  First and foremost, the hint that execution maybe less important strikes is a half-baked idea.  Also, from an analytical, data-driven perspective, we’ve completed a similar study which found that companies that control attrition and grow organically (both functions of resource allocation and the management of the corporate portfolio) actually outperform their peers on a shareholder returns basis.  Our findings reveal that not all dollars of top line growth are created equal and that in fact, the market favors a dollar of organic growth more than one from M&A.  Part of the discount for M&A revenue maybe that it is risky.  Look at the history of M&A deals and it is obvious they are inherently and highly uncertain. 

What about the market growth piece you might ask?  As I speak about in the aforementiond article, “Market growth in the near term is really not under an organization’s control. If you happen to be in an industry growing at double-digit rates, good for you. Conversely, if you are in an industry that is growing at a slow rate or even shrinking, too bad. The short of it in either case is that there is not much you can do in the immediate term to juice market growth.”

The short of it is that portfolio repositioning strategies are sexy as is M&A, but both are uncertain, costly and time-consuming.  To deliver better returns, the component of growth most under an organization’s control is what should be optimized and that is organic growth.  Furthermore, the organic growth can come from a variety of sources including from existing customers as well as the creation of new services & products through innovation.  It is likely that these are more controllable and hence the value per unit of risk that is possible is higher.  Companies like AmEx and P&G have realized this and continue to be rewarded by the market for this. 

Execution matters the most and drives the most important lever of revenue growth - organic.  M&A is a miserable way to grow revenue and portfolio positioning, while important takes time and is not something that can be changed quickly.  Additionally, positioning your portfolio in higher growth segments also means you will compete with others head on who’ve also realized the growth in this segment.