Download Will high-tech CFOs adapt to slower growth

Will high-tech CFOs adapt to slower growth?
The McKinsey Quarterly, Web exclusive, October 2004
Financial officers in the high-tech sector should learn to balance six roles to help guide
companies into a more mature market.
Bertil E. Chappuis, Kevin A. Frick, and Paul J. Roche
The technology industry has changed dramatically in the past five years, and so have the
demands on its CFOs. While some thrived as strategists during the boom times, others
steered clear of mergers and limited themselves to the role of controller. Now, in a time
of slower growth, high-tech CFOs must broaden their responsibilities by paying more
attention to the factors that drive value in mature companies, such as measuring and
improving productivity. This approach to growth isn't as sexy as mergers and
acquisitions, but it is required at this point in the sector's evolution. In other words,
technology CFOs must become more like their peers in other industries.
The missions of CFOs
Over the past year we studied the role of CFOs in high-tech companies to see what
makes executives effective in that position. Through our research and discussions with
38 CFOs, we identified a financial officer's six missions. These roles may be familiar to
CFOs in other kinds of companies but not necessarily to those in the technology
business. No CFO we spoke with excelled at all six. Chief financial officers who did
excel at this whole range of duties would become the most important advocates of
productivity and value within their companies (see sidebar, "Balancing roles").
Act as the keeper of the business model
The chief financial officer must understand the company's blueprint for making money
better than anyone else. Armed with that knowledge and with a thorough grasp of
industry trends and economics, the CFO is in a unique position to know what will affect
the company's stock price. As technology markets mature, an informed CFO should
initiate discussions with other top executives about how the business model ought to
evolve. The CFO at one software company, for example, helped its senior-management
team to see that its core source of Fortune 500 accounts would soon be exhausted. This
realization led the team to target smaller companies. The CFO then began a dialogue
about whether to augment the company's direct-sales efforts by using its channel
partners to exploit the indirect channel—an approach better suited to the economics of a
fragmented customer base.
Furthermore, new initiatives can sometimes hurt individual business units even while
benefiting the company as a whole. CFO’s, who are not tied to any one unit, can
objectively judge the overall interests of the company and therefore help arbitrate in
such cases. At one computer manufacturer, for instance, the CFO showed senior
managers how they could reach their revenue targets by expanding a services business,
even though it delivered lower gross margins that had to be compensated for in other
areas of the company. The CFO played a critical role in determining the pace at which it
should expand the business and the level of investment that would be needed to do so.
Prioritize initiatives
Management teams often suffer from an overload of initiatives, and the chief financial
officer can use information from the capital markets as a pragmatic and independent
way of prioritizing among them. By analyzing the reactions of the markets to any given
change and identifying the levels of growth, profitability, asset turnover, and capital
costs that will excite investors, a good financial officer can help managers identify their
most promising initiatives.
The CFO at one software company, for example, compared the relative impact of
growth and higher margins on the company's share price. He found that the latter had a
bigger effect, so he introduced a company-wide initiative to increase productivity. To
win the support of the chief executive and the head of the largest business unit, he
linked operating-profit targets to investor expectations and the performance of
comparable companies—both critical priorities for the CEO. Once the manager of the
top business unit became interested, others followed, and they launched a review of the
company's processes. Operating margins had been in the low to mid single digits but
rose to the upper teens within nine months. The company's share price more than
doubled over the same period.
Ensure accountability and fact-based decision making
Although companies in all industries struggle to obtain consistent and reliable data to
help them meet their strategic and operational goals, the problem may be more severe in
the technology sector. Most high-tech companies have grown rapidly, and the internal
information systems they set up as recently as five to seven years ago may no longer
provide relevant data. They have also been through more mergers and acquisitions than
most companies, and though you might expect tech-savvy management teams to have
experience successfully integrating IT systems, few of them have actually undertaken
such a project. As a result, M&A often leaves in place a number of accounting and other
measurement systems.
When such information is inadequate, a CFO's first priority should be to set up systems
that deliver it, on time, to the people who need it. This might seem to be a basic step,
but many technology enterprises resemble the software company that had more than 80
separate databases to track customer information. As systems improve, the finance team
can analyze the data and help business managers to do so as well, thereby delivering
what one CFO called "insight, not Your javascript is turned off. Javascript is required to
view exhibits.
Many companies rely on key performance indicators to shed light on their financial and
operational performance and to provide insight into the long-term health of the business.
Although these metrics have been around for years, they seemed unimportant when
technology companies were still growing quickly and focusing on the "next big thing."
In those days, improving a business unit's performance by an extra 5 percent may not
have seemed worth the effort. Today, however, share prices are more likely to be
influenced by growth in margins than by market share (exhibit). Big ideas still matter,
but execution is paramount.
Our research suggests that high-tech CFOs must do a better job of implementing
forward-looking metrics for market share trends, customer satisfaction, and employee
turnover (which affects labor productivity). They should also tie these metrics to
performance reviews. Many technology companies don't complete the loop by enforcing
accountability for success or failure; some don't even recognize the need to do so.
Convert operating income to cash flow efficiently
One of the CFO's primary responsibilities is to use the operating income of the company
in the most effective way possible by reducing its tax burden, minimizing its cost of
capital, and keeping asset turnover high. High-tech CFOs often pride themselves on
how well they manage these classic financial responsibilities, but we find that they
generally underperform compared with their peers in other industries—often because
they haven't adjusted to the new realities. Many academics and leaders from other
industries would argue, for instance, that given the increasing maturity and
predictability of some parts of the sector, a high-tech company's capital structure should
have higher debt levels to reduce the cost of capital. Yet a lot of the CFOs we spoke
with refused to entertain that notion, citing the outdated rationales of volatility and
convention.
Understand investors and tailor communications to them
Much as product developers and marketers segment a customer base, the CFO should
work with the investor relations team to segment the universe of potential investors. The
company can then identify those groups whose interests closely match its value
proposition and develop plans to attract others as well. This kind of communications
effort is especially important for tech companies, many of which are shifting their
business models and offering investors a new, longer-term perspective. One chief
financial officer revamped the investor relations program of his company to appeal to
20 prospects; 18 of them eventually made its list of the top 20 shareholders.
To reach these investors, a CFO must analyze their needs. One imaging company had
historically focused 90 percent of its investor relations announcements on a business
unit with high growth potential. When the company examined its investor base,
however, it found that most of the shareholders were more interested in the largest
business unit, which generated a substantial cash flow but little buzz. The CFO retooled
communications around the cash-generating part of the company, a move applauded by
investors and analysts alike for increasing its transparency.
One way a corporation can refine its focus is to choose which metrics to report. A
certain CFO wanted investors to think of his company not as an Internet business, as
they had before, but as a media enterprise. Therefore, he began publicizing metrics,
such as revenue per subscriber, more typical of media-related stocks. His move was in
line with the decision many companies have made to report only key business metrics
instead of offering guidance on future earnings. As one CFO put it, "My role is not to
predict future earnings per share but to tell the market what they need to know in order
to fairly value us."
Represent the shareholders
New corporate-governance regulations in the United States and Europe require CFOs to
attest personally to the accuracy of any financial statement. Most are therefore keenly
aware of their role as "chief integrity officer": the manager who ensures that
shareholders are served properly. CFOs generally believe that recent governance
problems resulted not from too few rules but rather from poor enforcement. They
should thus go beyond basic compliance and serve as role models for good practices
throughout the organization. One CFO, for instance, told us how she spends time
reviewing accounts with her receivables team—a job that, while tedious, emphasizes
"the need to pay attention to details."
Becoming a better CFO
High-tech CFOs must shift the financial focus of their companies from short-term
growth to long-term value. They can take several steps to make this transition as smooth
as possible.
First, they can concentrate on building a strong finance team. One CFO told us that he
wants to spend his time talking strategy with business-unit managers but can't, because
he doesn't have people he can rely on to manage the new regulatory obligations. If
CFOs are to expand their role, many will have to bring in qualified talent, either from
the business units or from outside the company. In investor relations, for example, some
CFOs are bringing in marketing stars who can apply segmenting, targeting, and
positioning know-how to the investor base. A software CFO is conducting an external
search to recruit qualified controllers who can manage the finances of newly
reorganized business units.
Second, it is important for the CFO to have the support of the CEO and other top
managers, especially at critical moments. For the aforementioned CFO who launched a
productivity-improvement effort at a software company, the moment of truth came
during the budget process. All of the operating managers were lobbying the CEO for
target relief but he didn't budge, and his support gave the CFO a new level of
credibility.
Thanks to the push for corporate-governance reform, CFOs have also developed more
direct relationships with their boards of directors, particularly the audit committee. One
goal is to reassure investors that the board is receiving information that has not been
filtered through the chief executive, although the chief financial officer reports to the
CEO. This connection between the directors and the CFO fosters dialogue that helps the
CFO learn where investor support can be found.
Third, CFOs can use process initiatives to gain traction with executives and to establish
themselves as value managers, thereby embracing their traditional control function and
establishing a stronger influence on operations. Moving beyond the narrow specialty of
CFOs in this way can help them build credibility within the organization. Although they
could concentrate on managing value in the finance function, they can expand their
influence most effectively by selecting an area with company-wide implications. CFOs
who began as controllers should choose a more strategic activity, such as guiding senior
managers through the decomposition of the stock price. Those who have previous
experience in strategy may want to select something more operational, such as setting
up a fact-based performance system.
Productivity is a popular platform for extending the role of the CFO, who usually
analyzes movements in the company's share price to determine what raises value. This
understanding, in turn, informs the focus of the productivity-improvement program:
operating expenses, performance, profit-and-loss targets, or a range of other metrics.
Once targets are set, the CFO has a platform for talking with business-unit managers.
By pinpointing where costs are incurred, these conversations can shape the way the
business operates.
Pricing—another area where CFOs are extending their reach—is traditionally the
domain of sales and marketing. Now CFOs are beginning to use their financial expertise
to calculate the impact of pricing decisions. At one tech company, this new
understanding led the CFO to revamp the pricing methodology.
Moreover, though renewed scrutiny of accounting controls may weigh down a
company's reporting systems, it can also give CFOs a way to reevaluate financial
processes. At one software company, the CFO combined the control function with new
initiatives supporting business goals. Recognizing that the company's numerous orderentry systems threatened the credibility and timing of its financial reporting, he led an
effort to consolidate them into a single system and then launched a project to redesign
the quote-to-cash process.
The technology sector is maturing, but many CFOs haven't adapted to the new
environment. They need to focus on rebalancing debt ratios, on courting investors who
seek long-term value, and on improving productivity. A strong platform and the support
of the CEO and the board can help a CFO become an effective advocate for
performance and shareholder value.
Balancing roles
In our interviews with high-tech financial officers, we found that 40 percent of them
tend to focus on the traditional controller aspects of the job and 25 percent on the
expanded strategic duties that were so important during the late 1990s. Only about a
third do a good job of balancing both.
Those who emphasize the controller side are often accountants by training—they rank
taxes, auditing, and control functions as their most important duties. CFOs who could
be described as strategists have backgrounds in corporate development (managing
strategy and M&A), line management, investment banking, or consulting. They are
more likely to oversee M&A, information technology, and, sometimes, human
resources and legal affairs (exhibit).
enlarge exhibit
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The most effective financial officers combine both roles. They keep a firm grip on the
controller function but also serve shareholder interests by using their insight into
corporate finances and their independence from any single business unit or operation to
help drive strategy. We call these financial officers "value managers," and the
companies in our sample that employ them tend to be better performers. More CFOs
should aspire to play this role.
About the Authors
Bertil Chappuis and Paul Roche are principals and Kevin Frick is an associate
principal in McKinsey's Silicon Valley office.