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Managing Profitable Growth: The CFO’s Role                                                                                                

by Frank Cespedes and Jason Smith

The goal of strategy is sustained profitable growth, and that means earning returns above your cost of capital or what economists call “Economic Profit” (EP). Companies seeking profitable growth, therefore, face two interdependent tasks: grow the top line and manage the costs and financial efficiency of their customer-acquisition efforts. While sales growth contains the “sizzle,” continuous cost-productivity improvements are the “steak” that feeds the bottom line.

But these tasks are often disconnected in companies. Employees then view cost-reduction initiatives as “what Finance does” (if Finance does them) in a series of one-time initiatives, not an ongoing process. Conversely, the top line is Sales’ domain and Finance does after-the-fact scorekeeping of revenues and margins. The results of that silo’d approach are not good. An analysis of nearly 3,000 nonfinancial companies from 2007–2011 found that the top quintile of firms accounted for 90% of all the EP measured, while the bottom two quintiles destroyed more than $450 billion in EP during this period.[1]

CFO’s Role

CFO-RoleCFOs can change these results by providing leadership and shining light on key links between sales activities, cost management, and profitable growth. To play that role, a CFO must set clear goals. Cost management requires training, preparation, and hours of execution, so pick your shots, not try to manage too many categories too quickly. Prioritize the important areas (usually those with the greatest saving opportunity) and establish the right metrics for measuring effectiveness on an ongoing basis.

In setting those priorities, many firms should start with sales, because that’s where the money is. U.S. firms spend about $900 billion annually on sales efforts–more than 3x their total advertising spend, more than 20x their spending on digital marketing, and more than 100x their current spend on social media. Selling is a big cost center in many firms.

Selling activities also directly impact EP. Two ways that any company increases economic profit is 1) by investing in projects that earn more than their cost of capital, and 2) reducing investments in activities that earn less than the cost of capital. Most cap-ex is driven by revenue-seeking activities with customers. Hence, the customers brought in by sales are a key determinant of which projects the firm invests in. Similarly, smartly reducing expenditures requires metrics to track the “real” profitability of customers in your portfolio.

Measuring Effectiveness

In measuring the top line, most firms focus only on sales volume. But revenues are often disconnected from the cost of capital. Accounting gross margins can be positive even as EP is negative. Also, metrics should change as the market or strategy changes so that, in managing costs, managers are motivating the right things for today, not yesterday. Here are two places not to overlook in setting priorities for continuous improvements in financial efficiency:

Price versus Cost-to-Serve: Some customers require more sales calls, or geography or product customization or post-sale service requirements make them more or less expensive to serve. Some buy in large, production-efficient order quantities, while others buy with many small orders that affect operating costs across the selling firm. If you can’t measure cost-to-serve, then you will face several challenges. Your salespeople will chase volume, and you can damage your business system as well as profits. You won’t allocate available resources optimally. And you are ultimately at the mercy of competitors who can measure their cost-to-serve and do these things more effectively.

Do the following exercise: chart on a simple matrix the X% of customers who account for 60-80% of your current sales volume. The vertical axis is the price they pay you, and the horizontal axis is your total cost-to-serve that customer. When companies do this, most find accounts scattered randomly across this matrix. If so, recognize the market reality: in effect, you are asking some of your customers to subsidize others. Sooner or later, a competitor, a supply-chain consultant, or their finance people will alert those buyers to the reality and their cost-saving opportunity.

Cash Flows and Selling Cycle: Cash flow is even more important when capital markets and banks are less liberal lenders after the financial crisis. Cash flows in most businesses are closely correlated with the length of the selling cycle. Studies show how sales efforts affect cash flows, especially if your firm sells across diverse sectors of the economy.

Sales-CycleThe selling cycle affects other aspects of EP: funding requirements and the cost of capital itself. Financing needs are in large part driven by the cash on hand and the working capital required for conducting and growing the business. Most often, the single biggest driver of cash-out and cash-in is the selling cycle. Accounts payables are accumulated during selling, and accounts receivable are largely determined by what’s sold, how fast, and at what price. That’s why increasing close rates and accelerating selling cycles is a Finance issue and not only a sales task.

Cost improvements should be an ongoing process, not a one-shot deal. And if that process doesn’t include sales activities, it’s often just nibbling at the margins, not increasing profitably the size of the pie for you, your people, and your investors.

Profitable growth means earning returns above your company’s cost of capital while anaging the cost and financial productivity involved in the customer acquisition efforts required for growth. And it’s a two-way street. Sales growth in which profits exceed the cost of capital can enable a company to implement improvements to cost management, thus growing the bottom line. But this requires a well-planned strategy, the leadership of key company players from multiple organizational departments, and a method to measure the effectiveness of efforts as a market changes..

Results have proven that a silo approach to increasing profit margins is not effective. Developing a strategic method for growing businesses and keeping costs at bay is a dynamic, ongoing process that requires the collaboration of other departments, especially Sales as well as Finance.

Those holding leadership roles in a company must establish lucid goals and a clear method to train, prepare, and execute an effective strategy. The CFO is key, particularly in planning, distribution, execution, and establishing metrics for profit growth and cost management initiatives. Once the areas of priority are identified, moreover, implementing a plan should be an ongoing process that requires constant monitoring to ascertain effectiveness and maintain momentum.

When identifying areas of priority, sales is often a focus because of amount of money that is spent in that area and because sales efforts have a direct impact on the projects and accounts and other assets in which a company invests time, money, and people. . All of these areas must be measured; it is not only about the top line and sales volume, but also about what cost it takes to keep the machine running.

Growth operating costsTherefore, two areas that are often overlooked but important to include in evaluations of financial efficiency are “Price vs. Cost-to-Serve” and “Cash Flows and Selling Cycle”. Cost-to-serve different customers and segments is something that must be measured so that resources can be allocated properly. The flow of cash is also vital. Research has shown that cash flow is directly related to the length of the selling cycle; thus, increasing close rates by the sales group is a strategic as well as sales issue.

Profitable growth and cost management are not opposites; in fact, they are intertwined in high-performing companies. And they should be linked in a dynamic process that can change as the market alters. The process should involve finance and sales. If you omit either, you increase the risk that, even with a great business strategy, your company’s bottom line can show significant loss for the business owner, employees, and investors.

Frank Cespedes teaches at Harvard Business School and is the author of Aligning Strategy and Sales: The Choices, Systems, and Behaviors that Drive Effective Selling (Harvard Business Review Press). You can purchase his book at Amazon

Jason Smith is the founder of Max Profits and the author of “7 reasons for internal resistance to cost reduction and 7 solutions”. You can download this white paper at operatingcosts.com

REFERENCES

[1] “The Strategic Yardstick You Can’t Afford to Ignore,” McKinsey Quarterly (October 2013).

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