The world is in a period of instability with many unpredictable changes. A global pandemic, hyperinflation, regional crises and rising interest rates are challenges businesses must face. The future is more uncertain than ever, making navigating the business environment extremely difficult.
However, to survive and grow, businesses are forced to adapt and find new directions. Business leaders, especially CFOs and finance teams, play a critical role in making informed decisions to guide the company through this difficult time.
To manage the “Next Normal” – as McKinsey terms it – CFOs need to develop the ability to ensure their companies outperform their competitors in any environment.
As a result, managing the “Next Normal” is one of the top priorities for CFOs in 2024. This article will dive into how CFOs can develop this readiness and what next steps to take.
Control the unexpected
Most companies today often react passively to events beyond their control. Many people believe that proactively dealing with things that cannot be controlled is unthinkable. However, that is absolutely not true. It's possible to prepare for the unexpected, and it starts with identifying available options early in strategy development.
>>> See more: 3 strategies to help CFOs thrive in an uncertain economic and financial environment7 Steps to Managing the “Next Normal”
Let's take a closer look at each step in the “Next Normal”:
1. Know your strategic options
Strategic choices are an important aspect but can be daunting for CFOs because the number of options seems limitless. However, you can simplify this by categorizing your choices into a few main categories.
According to McKinsey’s in-depth strategy research, the key factor determining success is the number of “Big Moves” that the CFO makes. The “Big Moves” include:
- Mergers and Acquisitions (M&A)
- Reallocate resources
- Capital expenditure
- Improve productivity
- Improved differentiation capabilities
The CFO needs to make two or three “Big Games” over the next ten years and put all his energy into them. Without making these moves aggressively, the company will not be able to differentiate itself significantly from its competitors.
2. Understand the economics behind each choice
To manage the Next Normal, CFOs need to carefully evaluate each “Big Game” to understand the potential value added from each. This evaluation is not just a financial calculation, but also includes an assessment of the company’s ability to execute.
The CFO plays a key role in this evaluation and needs to apply an objective approach. Executives may favor some options over others for personal reasons, but if business analysis shows that the performance is lower than other “Big Games,” that option should be eliminated.
3. Carefully document assumptions for strategic choices
This is the stage where many companies often become negligent. After thoroughly evaluating options and making decisions, they tend to overlook the importance of documenting the assumptions behind business analysis.
However, documenting assumptions is extremely important because they are the foundation for making effective strategic choices. This helps ensure that all stakeholders understand the assumptions and can jointly evaluate their reasonableness.
To do this, the CFO should hold strategy room discussions to review the assumptions for each option. Questions should be asked such as: “What needs to happen for this option to succeed?” “What do our customers, competitors, and employees need to do?”
This process can help the CFO realize that the likelihood of success for a particular option is very low, even if the business analysis looks good. This is a positive result because it helps make decisions based on more realistic data.
Although it may be concluded that an option is not feasible, it is still necessary to document the assumptions. Thanks to this, the CFO can retain important information for future assessments and decision-making.
4. Establish a confidence interval for each assumption
Once you identify the assumptions, you can synthesize them into 10-15 key assumptions with clear references. Next, you need to establish confidence intervals for each assumption. A confidence interval is the range of values within which you feel comfortable with actual fluctuations while keeping the original strategy choice unchanged.
For example, you predict inflation at 2%. Your confidence interval could be from 0.5% to 4%. If actual inflation is within this range, you can rest assured that your plan is still effective. However, if inflation moves beyond this range, you may need to reconsider your choice of strategy.
5. Develop alternative scenarios for each assumption
Even after you have made a decision and planned to execute the strategy, it is still necessary to discuss alternative scenarios. Ask questions like “what if” and “what would we do then” for each assumption. For example, you could analyze cases like:
- What about inflation at 5%?
- What about inflation at 0%?
This helps you develop contingency plans of action (or Plan B) to respond to unexpected situations. While you may not need to use these plans, if you do and don't have one, it can make the difference between success and simply surviving in the market.
6. Set up real-time tracking for each assumption
Tracking actuals against assumptions is critical, and ideally should be done as close to real-time as possible. Depending on the nature of the business, “real-time” could mean once a month or every second.
For example, in the case of inflation, you may only get official monthly data. However, there will be many other basic indicators showing the trend of inflation. Therefore, you need to decide whether tracking data once a month is enough or whether you need to monitor fundamental indicators more frequently.
7. When reality moves too far from assumptions, take action
Because you are monitoring your assumptions in real time, you will know immediately when the confidence interval is violated. When that happens, it will trigger a discussion about strategic action. Depending on the severity of the violation, the discussion may include the entire executive team or be addressed at a lower level in the organization.
You will most likely need to take action; however, it is important to perform a comprehensive assessment and not just focus on a single assumption. There may be other data points that show good performance despite the circumstances. For example, if inflation is 6% but you can increase prices by 10%, you may not need to take action even if the confidence interval is violated.
Whether the decision is to act or not, there should be a clear conclusion from the discussion of strategic action. Make sure to clearly define roles, responsibilities, timelines, and who is in charge of each task. This way, you can ensure your strategy is on track or proactively change before your competitors.
>>> See more: Strategy to "crack" profits against inflation pressure for FMCG businesses in 2024It's time for CFOs to reconsider their strategy
While this straightforward and logical approach is useful for strategizing and managing the “Next Normal,” the reality is that most companies don’t have a completely fresh starting point from which to fully embrace this process.
Instead, CFOs should proactively conduct a review of the company's current strategy or review its most recent strategic progress. Each step in the process has obvious questions that need to be answered:
- Strategic choices: What strategic options did we consider and what were the reasons behind those choices?
- Business Analysis: What is included in the business analysis for each strategic option?
- Assumptions: Do we have clear documentation of the assumptions used in the business analysis process?
- Confidence interval: How are assumptions established with confidence intervals?
- Alternative scenarios: Have we prepared alternative scenarios and actions in case the assumptions are incorrect?
- Track performance: How do we track actual performance against assumptions and strategic goals?
- Action in case of violation: How is the system discussing and deciding on action in case of violation of the confidence interval established?
In addition to the basic questions above, you may need to ask more specific questions for each step to clarify the process. Conducting a strategic review as an internal exercise within the Finance department will be a great learning experience for the finance leadership team.
Once you have completed the assessment, present the results of your discussion to your management team and agree on a common understanding. Ideally, you have most of the steps in the process in place and your current strategy is on track. However, the reality is that many strategies are not performing as expected. Therefore, the assessment process can help you uncover important insights to improve your company’s management of the “Next Normal.”
What approach are you taking to managing the “Next Normal”?
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