Connect Enterprise Performance Management Processes to Drive Business Value

By Ivo Bauermann, Senior Director Business Development, Oracle Corporation

This company had designed an important value management process, but it had not been able to fully implement the process due to changing accounting standards and regulatory compliance regulations. Sound familiar? Although multiple studies among finance executives indicate that the finance department has the opportunity to play a more strategic role, most are primarily focused on regulatory compliance and corporate governance issues. While compliance and governance are very important, it often seems the balance has been tipped towards risk aversion and away from value-creating behavior. Companies have lost focus of their true purpose: to create and sustain business value.

Is Value Being Destroyed?
A survey by Booz Allen Hamilton concluded "more shareholder value has been wiped out in the past five years as a result of mismanagement and bad execution of strategy than was lost through all the recent compliance scandals combined." While companies are focused on regulatory compliance, it seems that value destruction should be a greater cause for concern. Although the Sarbanes-Oxley Act brought much needed transparency and a restoration of investors' trust, according to Booz Allen's study, it "does little to protect the primary strategic and operational elements that [. . .] are the primary cause of shareholder value destruction."

Isn't it senior management's responsibility to understand and manage a company's value creation capabilities? Unfortunately a survey by McKinsey reports that, "It is surprising how many executives don't know exactly how their business units create value." Ouch. Fortunately, the CFO and the finance organization can play a critical and strategic role in encouraging value-based thinking in managing the business.

The case of one of the largest spirits and wine companies is illustrative. For this company, it was no longer sufficient to manage performance by region or product. Research has shown that brand-guided, as opposed to product driven, companies have almost double the profit margins compared to the industry average. The finance department decided to analyze different scenarios on margins and investment requirements by brand. Today, the company understands the contribution each brand makes to the company's share price and they can allocate resources based on value-added potential. As a result, the company can manage its business from a value perspective. And the finance department considers the software they use for this analysis "by far the most important analytical tool in the company."

The Convergence of Risk Management and Performance Management
Risk management seeks to protect value and this is one of the key objectives of regulatory compliance. On the other hand, performance management seeks to enhance or create value. Companies need to find a balance between risk management and performance management. The good news is that accounting standards boards have begun to adopt the central idea of fair or economic value. This means that financial reporting-traditionally focused on historical figures-should also give insight into the future cash flows of a company. As a result, the concepts used for value management now form a highly relevant basis for valuation in accordance with accounting standards. This gives finance organizations an opportunity to bring a balanced focus to enterprise performance management (EPM) by meeting regulatory compliance and accounting standards requirements and by pursuing value management activities.

Close the Loop Between Planning and Reporting
Imagine if you could be less concerned with explaining past performance and instead could focus on managing future results. Wouldn't that put you in a better position to drive business performance and value? To focus on the future, companies must avoid the biggest disconnect in management processes: the gap between the backward-looking reporting process and the forward-looking planning process. Typically, the reporting process answers questions about what happened to the business and why it happened. Reporting looks at actual results and historical information. A common goal for most, if not all, companies is to be able to report or rely on a single version of the truth. Often this goal becomes the focal point of companies' EPM initiatives. However, having a single version of the truth is only one side of the coin. If reporting is about collecting the facts to construct a single version of the past, then planning is about making assumptions to assess multiple versions of the future. Planning answers questions about what could happen and how it could be made to happen.

If companies want to plan well, they need to enter the realm of simulation. And they had better be good at it because of the impact on value. For example, brand value is determined by expected future cash flows and the business drivers and assumptions behind it. Given most companies' complex business environments, this requires sophisticated financial modeling. How do you prioritize investments and allocate capital to optimize the return on your product portfolio? To answer this question, you must go beyond simply looking at top-line growth and expenses. Instead, you must estimate expected cash flows and determine if there is a financing surplus or deficit. Does your capital structure support this strategy? Do you have enough cash do make investments? If not, is there enough capacity to take on additional debt or issue more shares? Will you generate sufficient cash to service the debt and provide a solid shareholder return? What is the impact on your credit rating or your bank covenants such as interest coverage ratios? These questions must be answered so managers can make the right decisions that impact the company's business value.

A good example is provided by one of the top global engineering companies. A few years ago the company found itself in financial trouble. It lost its investment-grade credit rating and, as a consequence, its line of credit. To overcome the liquidity crisis, the finance team understood that they urgently needed to recapitalize the balance sheet. They ran simulations on the company's capital structure and future cash generation. The results were presented to creditors and rating agencies that gained renewed confidence in the company's financial position. Most impressive was how accurate the finance team's simulation results proved to be: actual net income for 2005 was within 3 percent of the projection made in 2003. Such accurate forecasting was a sign to stakeholders that the company again had its business under control. By 2006, the company returned to an investment-grade credit rating.

Connect All Levels of the Company
A common myopia of EPM initiatives is that they often center mostly on the corporate function. But if companies want to truly drive and enhance their business value, shouldn't EPM encompass the entire business rather than just corporate performance? If companies limit the scope of an EPM project to the corporate function, they risk overlooking the specifics that affect business units. A corporate approach to EPM tends to be purely financially driven, rather than an examination of the true business and operational drivers of value.

Conclusion
EPM is most effective when management processes are seamlessly integrated across functions. Sharing strategic, financial, and operational information in an integrated way increases the success of EPM initiatives. When executed properly, EPM serves the needs of both the corporate functions and the business units (and/or divisions and operating companies). It ensures corporate consistency in order to gain insight into overall company performance, while simultaneously providing enough flexibility for business units to manage their specific performance and business drivers. Unfortunately, there is no one-size-fits-all approach to EPM.

Companies lured by overly simplistic approaches to EPM run the risk of ineffective implementations. Simple approaches to EPM may sound attractive, but if it were truly easy then every company-including your competitors-would be doing it effectively. It is because EPM is not so easy that your company can use it to gain competitive advantage. Leading companies understand that a more sophisticated approach to EPM puts them ahead of competitors. And this creates opportunities to enhance the value of the business.