The growth prospects of big companies have been uncertain for a long time now. And for good reason; the US economy continues to look strong, but the outlook is not universally rosy, just like Europe, which promises much but is weighed down by all the uncertainty surrounding Brexit. Elsewhere, China is still an engine of growth – albeit slowing growth – and emerging markets still promise much, even if political uncertainty means those promises aren’t as appealing as they once might have been.
All of this equivocation puts managers of the world’s big companies in an ongoing bind. The hundreds of research notes, presentations, etc that predict largely serene economic conditions over the next year or two have investors and commentators clamoring for business to invest in growth, but the concurrent uncertainty and risk has managers hesitating to give the go ahead to the large investments that kind of growth often demands.
It’s clear that markets have disproportionately rewarded companies that have taken bigger, riskier growth bets across the past 20 years or so, but that doesn’t mean it’s an easy decision to follow suit. Especially if companies have made a few “big bets” and they are not performing as expected.
Growth Bets Going Awry? Focus on the Right Ones
If a management team is worrying about its biggest investments underperforming, they may find some comfort in knowing that they’re not alone. The average return from growth initiatives lag a management team’s expectations by 25% or more at a portfolio level, according to CEB data. For the typical Fortune 500 company, that translates into 200 basis points of foregone growth every year, and – obviously – it compounds over time.
To improve matters, managers should make sure their process for investing in big growth bets shifts from simply making sure they’re selecting the right horses to creating an environment where investments are more likely to exceed the growth expectations that managers have for them.
When evaluating growth investments, most finance teams focus first on minimizing the number of projects that fall short of the expectation set out in the initial business case. Their underlying assumption is that as long as Finance protects the company from losing money to bad investments, the line managers will find ways to generate upside in good ones.
But in reality, Finance’s over zealous concern about losing money to bad investments often means that they fail to provide adequate funding to the good investments that require it. As a result, even the companies that excel at minimizing investment failure still sacrifice 100 basis points of growth per year, according to CEB analysis.
Spend More Time on Making Investments a Success
To remedy this, finance teams should balance their traditional focus on investment selection with an increased emphasis on managing existing investments in the portfolio. This means prioritizing the identification of risk during the investment selection process over other tasks, including spending less time upfront vetting market assumptions about whether the investment will be a success, using the expected returns from the investment to set business targets, and incorporating the expected impact of how the investment will perform into forecasts about whether or not a particular business unit will hit its targets.
Not only does this mean the whole business isn’t more worried that a growth bet will fail rather than excited that will succeed, but it also allows finance teams to spend more time creating an environment where funded projects are most likely to prosper.
From looking at how some of the most successful finance teams do it, managing investment performance to cultivate this type of environment consists of four main components.
- Reserving capital to fund in-progress growth investments that need it.
- Identifying when planned levels of funding for growth investments should be adjusted.
- Minimizing resource interdependencies between projects in the portfolio.
- Relaxing margins and increasing SG&A support where growth is anticipated.
When finance teams focus on these four imperatives, they introduce more flexibility into the investment management process so that resources can be more effectively allocated to investments that are most likely to exceed expectations.
It’s therefore not the complete avoidance of failure that sets the best companies apart; it’s actually the pursuit of over-performance that allows them to reap the full return on their growth investments.
Some of this may sound pretty ambitious — after all, making these shifts can change not just the role of the finance team as a business partner, but the direction of the entire company, but that doesn’t mean it’s not worth doing.