Playing To Win
How to Become a Strategic Chief Financial Officer
Be Master of the Strategic Economics of the Company
A retired CEO client and longtime reader suggested a topic that I agreed with him has high relevance and the potential to be broadly helpful. How can finance most effectively support an organization’s development of strategy? So, this Playing to Win/Practitioner Insights piece is How to Become a Strategic CFO: Be Master of the Strategic Economics of the Company. I have focused on the Chief Financial Officer (CFO) as the leader of the finance function, but the logic applies equally to everyone in the function.
Being Unhelpful
I am going to start with the negative for two reasons. First, the median contribution of CFOs to strategy today is negative — probably the contributions of only the top quartile of CFOs are positive. So, figuring out how to eliminate the negative will make the contributions of the positive much more impactful. Second, I would rather end on a high!
The biggest negative role that CFOs play is as the enforcer of proof. Most often the behavior is manifested in the insistence that no resources be allocated to any initiative without proof that it will succeed. And proof is typically defined in quantitative analytical terms — in good part because CFOs are trained to be quantitative and analytical. Since CFOs typically hold the purse strings, they can and often do enforce that rule or principle.
The problem, as I have pointed out numerous times before (for example here, here, here, and here), is that no new idea in the history of the world has been proven in advance analytically. CFOs often enforce an environment in which only existing things get funded — because there is much more apparent ‘proof’ concerning existing things. Ironically, ‘proof’ based on past data is often a frustratingly poor predictor of future events because the future is so often meaningfully different than the past.
But the effect is that CFOs play an outsized role in crushing innovation. When a new idea comes forward, as part of the process, the CFO insists on proof that it will succeed. Because proof in advance is impossible to garner, the innovative idea dies, and the innovators stop innovating or go somewhere else and do their innovating — like Thomas Edison who left his corporate job at Procter & Gamble to — well — invent the light bulb.
It is all very sad because CFOs don’t mean to crush innovation. They think they are being rigorous and prudent — on behalf of the company. I think of it like the historical practice of bloodletting. For 2000 years, ‘expert healers’ were guided by and enforced a theory that they had to keep bleeding the patient until black blood came out — because the black blood was what was making them sick. Sadly, despite their best intention, black blood is not the problem. It is what starts to come out when the patient is at death’s door — from the bloodletting.
It is the worst kind of delusion — one backed by confidence and perception of the moral high ground. CFOs can eliminate the biggest detriment of the finance function to the development of strategy by simple recognizing that rigorous analysis of the past is not a good or even useful predictor of the future and that there will never be proof in advance of an innovative new idea.
Being Helpful
If they eliminate that negative, what can CFOs do to generate the biggest positive? It is to be the master of the strategic economics of the company. And they can use that mastery to benefit strategy development in two ways.
Ensuring Logical Rigor
The first way CFOs can contribute positively to strategy development is to ensure that strategy decisions are consistent with the strategic economics of the company. By strategic economics, I mean the dynamics of revenues and of costs and how they interact to produce profits (or lack thereof). For example, to what degree costs vary with scale, or product line breadth, or geography, or all of them combined; and to what degree revenues vary with pricing approaches/structures?
The strongest tool of the CFO on this front is the What Would Have to be True (WWHTBT) question. Line managers and strategists can come up with strategy choices — we are going to differentiate in this way, or we are going to become the cost leader in that way — that sound sensible on their face. But to be choices worth making, they have to be sensible economically for the firm.
The CFO can and should play a key role in logically testing the economics of any proposed strategy. For a differentiation strategy, a CFO can ask WWHTBT about the price premium we will charge and WWHTBT about the volume for which we will achieve at that price premium and WWHTBT about our cost structure for producing our differentiated offering for the economics of the strategy — i.e. the strategic economics — to work. That is not asking for proof in advance. That is insisting on making the logical structure of the strategy explicit so that it can be assessed. If the CFO can make sure that the differentiation strategy specifies that it requires a given quantity of customers are willing to pay a given price premium, it can be more rigorously assessed than if there is only a vague sense that many customers must be willing to pay some level of price premium — and too often there is only a vague sense.
A great strategist will ask those WWHTBT questions without any initiative of or contribution by the CFO. But in my experience, many strategy authors don’t ask these strategic economics questions thoroughly and rigorously enough. For that reason, many differentiation strategies just don’t perform financially — and get a bad name. Often some customers will pay the target premium, but not nearly enough do, and the strategic economics collapse. Or the cost structure assumptions are not realistic for what the differentiation entails.
The same role of the CFO applies to cost leadership strategies. They can ask WWHTBT about the cost dynamics that would enable the strategy to produce attractive returns. I have seen far too many strategies that are described as ‘cost leadership,’ that have no rigorous underpinning of the logic. They are typically ‘cost proximity’ strategies — i.e. getting your costs down to approximately the level of key competitors. A strategic CFO will make sure that the strategy specifies the drivers of costs that it will exploit to ensure a demonstrably lower cost position than competitors.
If the CFO enforces logical rigor on the strategic economics underpinning any strategy possibility under consideration, then the consideration of possibilities will be elevated and the team making the decision can, as Aristotle admonishes, pick the possibility for which the most compelling argument can be made.
I remember fondly Sara Mathew who would go on to be the highly successful CEO of Dun & Bradstreet and Chair of Freddie Mac, as the CFO of the Tissue and Towel (think Charmin and Bounty) business of P&G tearing apart the implicit strategic economic assumptions behind the attempted globalization of what was clearly a North American business — and save billions in what would have been wasted investments. At the time, globalization seemed like a solid strategy to the powers that be. But it was anything but! And much later at Ford Motor Company, I worked with the Treasurer to fundamentally question the strategic economics of vehicle life cycle planning and production to dramatically improve the way the company thought about it. As a result, many vehicles that were designed to fail economically we no longer initiated or launched.
Again, some companies can achieve this level of logical rigor on the strategic economics underpinning of strategy possibilities without involvement of the CFO, but I don’t see it very often. And when I see a CFO who adds that dimension, it makes my job of propelling a management team toward bold strategy choice that much easier.
Creating Strategic Possibilities
CFOs can do more than ensure the rigor of other peoples’ strategy ideas. They can use their understanding of the strategic economics of their company’s business to generate strategy possibilities — possibilities that others without the deep understanding of the strategic economics cannot see.
Even though it was so very long ago in the late-1980s, I have the fondest memories of the time when the then-Corporate CFO of P&G, the late Erik Nelson, questioned the true scale advantage of the Tide laundry detergent business. With by far the biggest US detergent brand, the company had always assumed that it could marshal huge scale advantages in competing against its smaller rivals. But Erik didn’t see that advantage playing out in the numbers and wanted to understand why. As a result, we did what we came to call the ‘scale-of-what?’ study to understand where we took advantage of scale economies and where we accidentally dissipated them (for example with product line proliferation that might have made sense to a more naïve marketer but weren’t backed by the strategic economics).
Based on the findings, Erik pushed for a change in direction — which among other things ended up driving the powder-to-liquid conversion pace — which folks in the business led magnificently. But the motivation for the direction was helped by a CFO with understanding of the strategic economics pointing to possibilities for more fruitful strategic directions.
Funnily enough on this front, I find CFOs altogether too shy. On average, they are too aggressive on asking for quantitative proof of ideas before investment and too shy on contributing strategic possibilities. That is the proverbial lose-lose box.
Practitioner Insights
CFOs can play a hugely beneficial role in strategy development. It is not too far to suggest that it can be an essential role. But as with most great things in life, it requires letting go of some comfortable things and leaning into some uncomfortable ones.
The easiest thing for CFOs to do is to lean into the core of their training — and the personal characteristics that led them to get that training in the first place. And that is to enforce the need for quantitative analytical proof before investing in anything that has any hint of newness or innovation.
If you are a CFO (or anybody in the finance function), resist the urge. It will make you nervous. It will go against your entire education. Stop asking for proof about the future. There isn’t any. It would be handy if there were — though it would make like utterly dreary and boring (arguably worse than nasty, brutish and short).
Think of your job as raising the quality of the argumentation on the choice of alternative futures. You should see your job as helping to drive choice toward the most logically compelling possibility. Others will bring their particular skills to bear — customer understanding, knowledge of the distribution channel, production dynamics, etc. You need to bring your mastery of the strategic economics. It isn’t the only thing. It is one of a set of perspectives that need to be integrated into a strategic whole. And you can play a key role in doing that.
But also spend thinking cycles on creativity. What are possibilities that those who understand the strategic economics of the business less well than you would never imagine. Go to the folks that understand customers better than you to test your ideas. And the ones that know production, sales, and distribution dynamics better. But don’t be shy. Strategic insights can come from any direction — including yours but only if you give it a chance.
