They can take five actions to improve objective-setting, performance measurement, and cultural factors associated with successful innovation projects.
CFOs continue to have an innovation problem—or, rather, teams in their organizations think they do. Research shows that many business unit leaders view the CFO and the finance team as obstacles, not allies, to the innovation process.
That perception isn’t the reality, of course—but it’s easy to see why it exists.
Boards, CEOs, and others on the senior-management team rely on the CFO to be an independent arbiter and guardian against overoptimism—or conservatism—in annual planning and budgeting discussions and in performance management meetings. During these conversations, CFOs must help the rest of the senior-management team assess proposals from business unit leaders. CFOs must also quantify the potential value from those proposals while accounting for the inevitable financial and strategic uncertainties associated with new products or services or with process or systems changes.
To become true collaborators and allies for innovation—not just seen as authority figures holding the purse strings—CFOs need to change their colleagues’ (and in some cases their own) perceptions of their role in innovation. In our experience, a CFO can take five actions to flip the script: formally build innovation goals into the company’s plans for growth, discover and validate untested assumptions about an innovation project, speed up the standard budgeting process, establish metrics specific to innovation projects, and upskill finance teams and empower them to help lead changes in the company’s culture.
Making changes in these areas will take time and a commitment to developing an innovation mindset. But CFOs who make the effort may end up working more effectively with project teams and advancing corporate innovation in a way that dovetails with the company’s overall strategic aspirations and promotes growth and resilience.
How the CFO can better support innovation
At base, the innovation process is about allocating resources toward initiatives that create value for a company and, ideally, change an industry. To innovate successfully, companies must identify the most promising projects and set clear goals for realizing them, regularly measure progress in reaching those goals, and change hearts and minds—internally and externally. The CFO can promote success by focusing on the following five steps associated with objective-setting, metrics, and culture change.
The innovation process is about allocating resources toward initiatives that create value for a company and, ideally, change an industry.
1. Build innovation goals into the company’s plans for growth
The first step for a CFO looking to serve as an innovation ally is to formally build innovation goals into the company’s plans for growth. Where and how does the company expect to find growth, and what role should innovation play in securing it? With input from the CEO and other members of the senior-management team, the CFO can help answer those questions and devise objectives that compel teams to move beyond the status quo and explore new ideas, not just incremental process improvements. At one global insurance company, for instance, business unit leaders felt that they could hit their performance targets by tweaking existing operations rather than exploring larger initiatives. In effect, they felt they didn’t need to innovate to meet the company’s growth goals. Despite interventions from the top team, innovation languished for years.
To counter that thinking, the CFO could have established a “green box”—an effort to quantify how much growth in revenue or earnings a company’s innovations must provide in a given time frame. With this information in hand, the CFO and other senior leaders could have established new innovation-centered objectives for the business units—objectives focused on closing the gap between their current performance and capabilities and the company’s overarching growth aspirations. In this way, the CFO and the rest of the top team would also have communicated the fact that innovation was a priority for the finance function and the company as a whole.
2. Discover and validate untested assumptions about an innovation project
The CFO must acknowledge that standard planning and budgeting processes may not be suited to innovation. In most companies, business unit leaders present preapproved business cases to the CFO, and the two sides engage in back-and-forth about whether the proposal merits investment. In all likelihood, many of the assumptions underpinning the idea have already been tested—indeed, they are implicitly embedded in the company’s current business models. The decision to set a certain price for a product, for instance, often results from tested assumptions about, say, the customers’ willingness to pay for other products the company has launched or the perceived value from those products.
Innovation ideas, by contrast, are often built atop what may be untested assumptions. For instance, it’s very possible that the targeted customers won’t be willing to spend a significant amount of money on an unfamiliar product or a product with a different level of functionality. What, then, is the right approach to pricing?
The CFO and other leaders will need to discover and validate the untested assumptions associated with innovative ideas. The finance leader could start by asking business unit leaders how big an opportunity must be to justify moving forward. What are the most important assumptions we need to test? How can the finance function help business unit leaders get the data they need to prove the case and turn a good idea into a better one? To gain greater clarity about straightforward assumptions, CFOs may ask business unit leaders for literature scans, surveys, or other forms of research to bolster confidence in an investment decision. To gain greater clarity about trickier assumptions, they may ask for real-world information, such as data on experiments with minimally viable products, mock products, beta launches, or early partnerships.
For the CFO and finance team, the focus here should not be on costs but rather on creating a mechanism to explore the most promising ideas. They should, for instance, avoid using a hurdle rate that might
encourage teams to engineer their numbers. Instead, they should surface and challenge the business unit leaders’ assumptions and use them as the basis for important finance discussions.
3. Speed up the standard budget process
There is often a lag between budget and innovation cycles. A business unit might get approval for funding a project only to find, nine months into the annual budget cycle, that changes in technology or the market mean that more or different resources are needed. Innovation happens day to day and month to month—not once a year.
To be an innovation ally, the CFO must work with the rest of the senior-management team and the business units to change the pace and intensity of (and the dialogue around) resource decisions. For instance, the top leaders can institute monthly and quarterly reviews—or even more frequent discussions—as a catalyst for adjusting resources. Some businesses have even instituted stage-gate discussions for investments in new products, services, and other innovations. A business unit may receive a minimum spending base that covers costs associated with a product’s first iteration. Additional funding would be contingent on increases in, say, demand or delivery rates. The business unit would have to meet predetermined thresholds set jointly by it and the finance team.
This stage-gate approach can help clarify expectations, enable the business unit to change course if needed, and ensure that resources are allocated continually rather than cyclically. It can also help strengthen a company’s innovation pipeline: many innovations fail, so it is important for CFOs to take stock of projects frequently—and to help shift resources to the most promising initiatives and end unsuccessful ones.
4. Establish metrics specific to innovation projects
A big source of tension between CFOs and business unit leaders is how to report and measure the performance of new initiatives. In proposing them, business unit leaders often build multiyear revenue projections too precise for the context. In other words, they don’t account for the inevitable changes, in business drivers and assumptions, that occur when new products are launched. In the first year, customers may flock to a shiny new product—which would imply success—but what happens when demand drops off or attention shifts to a fast-following product?
To get past this disconnect, CFOs and business units can jointly establish metrics specific to innovation projects. These would include traditional business metrics, like the internal rate of return (IRR), net present value (NPV), and ROI. But they could also incorporate nontraditional metrics, such as customer loyalty or environmental, social, and governance (ESG) scores and the ranges of performance appropriate for certain types of projects or portfolios of projects. In addition, the CFO and the finance team can identify and use metrics that quantify the biggest sources of uncertainty from an innovation, the pace and efficiency of the innovation team’s learning process, and the opportunity timeline, among other factors.
Equally important, CFOs and business unit leaders must engage in an ongoing dialogue about how innovation projects are faring rather than conduct only periodic reviews or focus only on struggling projects. As noted earlier, it’s important to understand when and how to cut the cord on underperforming innovation projects—but it’s just as critical to understand when and how to scale up the successes.
5. Upskill and empower the finance team
In our experience, members of the finance team who have spent time in business units tend to understand the uncertainties of and become better advocates for innovation. For this reason, the CFO may want to facilitate employee rotations that can give members of the finance team greater exposure to the business units and the day-to-day decisions facing their leaders and innovation teams. In this way, members of the finance team can build important relationships and better understand the assumptions underpinning innovation projects. The rotation program can also be an important professional-development tool for the company. At a large consumer company, such a rotation was the stepping-stone for a financial-planning and analysis (FP&A) analyst who participated in and then led an innovation project that eventually turned into a new product line with a multimillion-dollar P&L.
Most important, the CFO should empower members of the finance team so that they receive ideas in the early stages. The CFO can have only a limited impact with a set of already polished financial plans. The potential for successful innovation is far greater if the CFO receives draft plans with the assumptions clearly articulated—and that won’t happen by accident.
CFOs need to make it safe to innovate. The CFO can help to maintain a nonjudgmental tone in innovation-related conversations. Rather than flatly asking business unit leaders, “How did you come up with this number?,” the CFO can reframe the question as a point of appreciative inquiry: “I see this assumes we can convert 10 percent of customers. I wonder how we might be able to validate the take rate?”
CFOs need to make innovation fun. One company used a competition-style format to source new ideas. The CFO asked teams to come to the leadership with product, service, or process ideas and make the case for funding. The company gave bonuses and recognition to teams that made submissions. That created excitement, which encouraged people who may have hesitated to push ideas through the application process to do so in hopes of getting selected to present them to the C-suite.
CFOs need to make innovation easy. Another company has built lots of reversible decisions—or “two-way doors”—into the innovation process, so that it is easier for teams to test and learn from new initiatives. These two-way doors can mean fewer sunk costs for innovation teams, faster go or no-go decisions, and, ideally, faster times to market.
The long-standing perception of CFOs as obstacles to innovation is stale—and mostly incorrect. CFOs who perpetuate the old mindsets and processes associated with innovation initiatives may put their organizations’ long-term health and viability at risk. But those who work to become innovation allies stand to boost value creation substantially and to improve both the company culture and the bottom line.
Post a Comment