For CFOs, Gray is the New Black and White: Risk in an Agile World

An Insight from the 2019 CFO of the Future Summit

Part of a Series

This Insight is taken from the 2019 CFO of the Future Summit.

An educator and consultant to major corporations and Innovation Fellow with Duke Corporate Education, Joe Perfetti is a corporate strategy and finance expert. He joined the CFO Summit to offer practical advice about rethinking risk and creating an Agile Dashboard. This article is inspired by and reflects some of the themes of his presentation.

Building the Aptitude for Change

CFOs today must embrace ceaseless change. The average company in the S&P 500 will be on that list for just 12 years by 2027. That is half of what it was in 2012, and about one-third of what it was in 1964. The downward trend line is unmistakable. Darwin was right, as Perfetti observes. Survival of the fittest is alive in well in today’s corporate world. And only the fast survive.

The hyper speed of change is reshaping traditional drivers of strategy and performance. Harvard Business School’s Michael Porter is a founding father of management strategy whose ideas about competitiveness shaped a generation of successful executives. His view was that you found an attractive industry, protected your markets with a competitive advantage and then extracted excess returns from your customers prevailed for decades. Industry selection was critical as it could drive as much as half of a company’s performance. He created a consulting firm called Monitor to advise leading companies on market selection.

Today, that view is changing. Rita McGrath argues in her book The End of Competitive Advantage that advantage is transient. It is not sufficient to build a moat around a castle as the world may move on and no one will even want to invade your castle anymore. Today it is the wave theory. Advantage is a wave that is going to crash. It is not a question of if, but when. And more importantly, what is the next wave. In a bit of irony, Monitor went bankrupt in 2013 as selecting attractive industries is not enough.

"We have to start changing our mindset in an agile world… I’m not saying it’s easy—no. It’s a paradox. You have to think long-term, but you have to make it to the long term."
Joe Perfetti
Duke Corporate Education

Jack Welch stated in the 2000 GE Annual report that, “We’ve long believed that when the rate of change inside an institution becomes slower than the rate of change outside, the end is in sight. The only question is when.” He was prescient in predicting his own company’s demise.

The impact on companies is dramatic. Organizations must move more quickly and be better able to pivot to take advantage of opportunities and adapt to market challenges. They must be able to do this more quickly than competitors if they are to achieve advantage in this emerging environment.

Agile: From Complicated to Complex

In describing these forces of change, Perfetti is bringing to life the fundamental aspects of an agile world. He explains that the business landscape has evolved (and continues to evolve) from complicated to complex. While the distinction between the two might seem like a matter of semantics, it is quite profound.

Perfetti offers a revealing analogy here to bring his point to life. Think of the differences between chess and poker. Chess is a complicated game. While it is difficult and takes time and patience to master, it is solvable with enough time and effort. In a game of Poker, on the other hand, you must bet without knowing what that next card will reveal. No amount of effort will give you the solution you seek. You must act under uncertainty and with probability as the answer will only be revealed after the fact.

Companies must not be paralyzed by indecision. As Jeff Bezos of Amazon says, you must go with 70% of the information as waiting for 90% will take too long and not provide you with significantly better outcomes. It is not about failing fast, but “failing well” as described by Google. If I can get more information than my competitor, learn faster and translate the learning into more actions I will win the race and have advantage over peers in the market.

A Brave New World for CFOs

CFOs are on the frontlines of this landscape of complexity. In fact, it is challenging everything they have traditionally done in their roles—especially their attitudes toward and relationship with risk.

By definition, CFOs are corporate gatekeepers, masters of risk avoidance and mitigation. They are the Dr. No of the organization. While they will always be charged with policing risk, doing so is a completely different undertaking in an agile world, says Perfetti. De-risking used to be an exercise in driving toward certainty. But now certainty is a mirage. And too much de-risking can actually trap a business in the past, choking future opportunity, and making it impossible to be agile.

What is the impact of this reality? CFOs have no choice by to embrace uncertainty, even though it goes against the grain of their expertise and natural mindsets. Instead of seeing it as the enemy, they must find the value in variance, in building ranges and optionality into budgets and strategic plans to account for the unknowns—both good and bad—that will impact the future of the business. In addition, they must excel at confidently and clearly communicating these variances to stakeholders inside and outside of the company. We must look to acquire options and build flexibility into our systems to move through and exploit the uncertainties. We must also look at failure not as loss but as an opportunity to learn. Note that to value an option you do not need to know the ROI of the investment. The primary driver of the value of the option is the range of the outcomes. Options become more valuable as uncertainty increases.

Beyond this new lens for risk, another big change for CFOs in the agile world is managing the short-termism that has often defined the role. The CFO has been held captive by quarterly calls. Playing what Perfetti calls an “expectation game,” CFOs in public companies are beholden to investor and analysts’ expectations that they hit their numbers every quarter. If they do not, they face the consequences. This dynamic creates missed opportunities to be more agile and take conscious losses today to invest smartly for bigger gains tomorrow. This is also what Perfetti calls the “Innovation Paradox.” Large companies are in the best position to fund uncertain initiatives and can bring resources to bear that startups cannot. Yet the need for increased certainty all but kills innovation at the company.

Traditional attitudes toward failure also limit CFOs’ ability to master complexity and be more agile. Most CFOs—in fact, most people—view failure as a negative and do everything they can to avoid it. After all, failure is a dreaded outcome of risky actions. But agile CFOs understand that failure is unavoidable when a company moves at market pace. They know that failure is the best teacher, and the parent of innovation. We must look at early investments as investments. Am I willing to place a small bet to get more information about an opportunity should be the question rather than can I justify an Net Present Value (NPV) with certainty for all early stage businesses?

Perfetti’s discussion of these differences for CFOs uncovers something fundamental about agility. Being agile is not about “and” or “or.” Agility is a series of paradoxes. It is about “both.” It is about the gray areas. In other words, agile leaders and organizations excel at managing the tension between two diametrically opposed forces. They embrace the paradox of being stable and flexible, thinking big and acting small, and protecting the core business while building the edge.

Traditional attitudes toward failure limit the CFOs’ ability to master complexity and to be more agile.

Living in the New Normal

There is no magic formula for driving more speed, dexterity and agility into an organization. However, Perfetti argues that doing this requires that organizations manage in systems, not silos. They must invest in optimizing market, organization and human systems and manage the interactions within and across them.

For the CFO specifically, an agile dashboard becomes an indispensable management tool toward this end. By measuring and improving their organization’s speed, interaction time and ability to pivot, they can let go of the past and help create a more agile future.

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