The role of chief financial officers in agile organizations
Transformational chief financial officers have a critical leadership role to play.
As organizations navigate a world of disruptive change and quickly changing markets, the role of the chief financial officer (CFO) is evolving – and fast. CFOs no longer simply ‘keep score’ by measuring financial performance. Increasingly, they are involved in leading the transformation of organizations, reflecting a changing definition of value creation. We are in the era of the transformational CFO.
For many organizations, this rethinking of the finance function could even be a matter of survival. The strategy consultancy Innosight calculates that in 2017, the average tenure of a company on the S&P 500 index was 24 years – yet by 2027, they forecast, the average tenure will have halved, down to just 12 years. That drastic fall compares to the high watermark of 33 years’ average tenure in 1964. Building an enduring company with a sustainable business model is more challenging than ever.
The traditional role of the chief financial officer is to be a responsible steward of organizational value. Yet in today’s hyper-competitive economy – given the common organizational imperative of creating value – CFOs should no longer just be shepherds of an organization’s financial capital. Transformative CFOs must also have a laser-like focus on their organizations’ human, operating, intellectual and economic capital.
How the role of CFO is evolving
The domain of the CFO has been expanding rapidly. Anthony ‘Toby’ O’Brien, CFO of aerospace and defence manufacturer Raytheon Technologies, has remarked that he was involved in more human resources meetings than ever before while managing the integration between Raytheon and United Technologies, during their merger. As human capital and talent have become more and more important for companies, managing their value has become an essential task for finance.
More broadly, CFOs are increasingly focused on managing business key performance indicators (KPIs), in addition to traditional responsibilities for financial planning, results and budgeting. They are leading organizations through scenario-planning and building value strategies. Sustaining a profitable business today demands investment to address emerging trends and consumer needs, even when that means disrupting existing business models and expanding core capabilities. In essence, CFOs need to move past scorekeeping, helping organizations avoid the tendency to get mired in the details of the past by developing business KPIs and sensors that are forward-looking and help the organization find inflection points in the market – what Rita Gunther McGrath calls “seeing around corners”.
Transformational CFOs also need to manage the capabilities and competencies of their organizations, going beyond their traditional role of managing a capital allocation process focused on investment in assets and pay-outs to investors. Consulting firm Bain estimates that a company should invest approximately 30% of its resources into “edge businesses” – the business of tomorrow – because the core business, or the business of today, will eventually mature or become disrupted. Understanding how and where to allocate investment drives value. Such reallocation of resources is not just about capital, or repurposing cash: it’s also about reallocating the people, physical assets, intellectual assets, and the core capabilities of the company. In addition, the transformational CFO moves beyond the traditional remit of cost reduction, to focus on improving processes. For example, investing in digital capabilities has become an important domain for CFOs looking to create a force multiplier for organizations.
The role of risk management is also evolving. The traditional focus was on mitigation or ‘de-risking the asset’. But in today’s VUCA – volatile, uncertain, complex and ambiguous – world, decisions often have to be made with uncertainty, and CFOs must leverage predictive analytics that help the organization act without complete information (while managing risk appropriately). Waiting for complete information before acting is no longer feasible because markets move at breakneck speeds. Making decisions and understanding the risk-to-reward profile of a decision are critical competencies, and ones that finance must cultivate among leaders at all levels in an organization.
The transformation of the CFO also requires a philosophical shift. Brett Biggs, chief financial officer of Walmart, has described his worry about being perceived by his organization as ‘Doctor No’. Colleagues seemed almost to expect that any request for capital would be denied. Transformational CFOs, however, find ways to say yes. They go ‘beyond the spreadsheet’ to become partners with the organization’s business leaders, helping to create alternatives, balance risks, and find paths forward that facilitate good decisions.
Another job of the modern CFO is to partner with investor relations to actively manage effective, regular two-way communications with key investors and the financial community. Increasingly, CFOs are being asked to educate the financial community on their organizations’ business strategy, competitive differentiators and long-term trajectory.
Similarly, CFOs play a vital role in internal education. Financial language can be a tremendous barrier to mobilizing change in an organization and CFOs can help managers understand, in simple terms, the business’s performance against the expectations of investors. They can make sure that financial decisions are transparent and that colleagues understand how they are made. CFOs are now spending more time coaching, mentoring and educating leaders on the concepts of value creation.
Perhaps the least obvious role for a CFO, but one of the most critical, is to develop and nurture a high-performance organizational culture. In the famous words attributed to Peter Drucker, “culture eats strategy”: to be successful, the transformational CFO must help leaders understand the essential contribution of culture to value creation. Culture is key to the successful execution of strategy, to improvements in operational performance, and to accelerating change in an organization.
Leading the transformation
For the CFO to lead a business transformation, it’s critical to have a clear understanding of how the business operates. Scott Walker, chief financial officer of Aetna, the Health Care Benefits division of CVS Health, always asks three questions to better understand a business. What is the business model of the company? What is the operating model of the company? What is the economic model of the company?
Answering these three questions and understanding the relationship between the answers is critical to driving any transformation or value-creation initiative at a business. Let’s consider each area in turn.
1. The business model
Understanding the business model means asking: “What businesses are we in, and how do we define our customers and address their unmet needs better than others?” It is the ‘who, why and what’ of a company.
After studying external forces and trends, and considering the opportunities to fix a broken healthcare system, CVS Health embarked upon a transformational journey, progressing from a health insurer to a personal, local, consumer-centric health company. The company’s goal is to leverage technology, data and analytics in order to serve as a trusted partner over the course of an individual’s lifetime of healthcare needs. By creating a different level of loyalty and trust, CVS Health can create and strengthen lifetime relationships and long-term value – both for the organization and the people they serve.
To do that most effectively, CVS Health must augment its more transactional business metrics with new ways of measuring success – both internally and market-focused – to better evaluate the company’s progress in achieving this goal of enhanced lifetime value.
2. The operating model
A company’s operating model describes an organization’s process, capabilities and organizational structure. Therefore, the second question to ask is: “How do we organize and align ourselves to deliver customers’ unmet needs most effectively?”
As CVS Health considered the implications of the CVS/Aetna merger, it had to consider its dual purpose as both a business-to-business (B2B) and a business-to-consumer (B2C) organization. Outside of structure, the company had to consider the vast capabilities of each organization and think creatively about how to organize and integrate those capabilities to drive value and create a differentiated experience for its consumers, plan sponsors – typically employers – and healthcare providers.
Combining with Aetna has been a game-changer for CVS Health and the healthcare industry. It brings together an enhanced suite of capabilities and assets that create a differentiated, personal, end-to-end healthcare experience that helps individuals tie their physical, emotional, financial and social needs together – all within the convenience of their home, their community, or the palm of their hand through a suite of digital tools. At the same time, the company is broadening the definition of healthcare by expanding networks to include alternative care treatment providers, and streamlining processes so that it is easier to do business with them.
Neither Aetna, nor CVS Health, would have been able to offer these solutions as quickly or as effectively as independent companies. Because of the breadth of combined assets, CVS Health is best positioned to coordinate the complex logistics around holistic healthcare.
3. The economic model
The third key question is: “How can we exceed our required cost of capital and meet our target margin profile?” A business that can hurdle its cost of capital is a sustainable business. It is vital to the CFO’s role to ensure that resources are aligned effectively to meet this commitment – yet sustainability is only part of the equation for transformational CFOs. They must also seek to understand how economic value is created and multiplied over time.
For CVS Health, one way to create value is by cultivating trusted lifetime partnerships with the people they serve over time. The company understands that healthcare is personal; there is no one-size-fits-all approach. Each individual they serve has unique needs, and therefore, each business segment has varying degrees of customer retention and profitability.
Like most companies, retention is a very meaningful lever for the business. The longer CVS Health can retain customers, the better it can understand their healthcare patterns, needs and challenges. In turn, the company can offer customized, personal guidance and new products and services to help individuals achieve their unique healthcare ambitions. That enhances its profile as a trusted advisor, strengthening the partnership with business clients and optimizing costs for the company over time. It is a win-win-win scenario for value creation.
Putting it all together
Companies are living organisms. They have a life cycle and are subject to evolving environmental shifts and pressures. The three questions posed here are useful in studying a business at various intervals of its journey and should not be considered in silos. Rather, the relationship between the business, operating and economic models is symbiotic. It must be understood and evaluated regularly to test and challenge assumptions and drive long-term organizational growth and viability. By ensuring synchronization between these factors, transformative chief financial officers can develop and lead effective and disruptive business strategies – while serving as true stewards of value creation for their organizations.
Joe Perfetti teaches equity analysis at the University of Maryland and is an innovation fellow with Duke CE. Scott Walker is the chief financial officer of Aetna, the Health Care Benefits division of CVS Health.