Strategic Planning (#280)
/In this podcast episode, we discuss the role of accounting and finance in strategic planning. Key points made are noted below.
From the perspective of the accounting and finance employees, there might not appear to be any connection with strategy, but that’s not really the case. Accounting and finance are linked to strategy in two ways, one in its formulation, and the other as a feedback loop. I’ll start with the second one, since that might seem a bit more familiar.
Strategy Feedback Loop
When management decides on a strategic direction, like launching a new product category or expanding into a new country, or using a new distribution channel, the amount of cash flow related to it is being monitored by the finance people, while the related revenues and expenses are being monitored by the accounting folks. Ideally, accounting and finance should be giving feedback to the management team about how their initiatives are working out. That doesn’t always happen, since accounting and finance may not even know what the strategy is – that’s pretty common. But if management clues them in on what’s happening, then they can look at the financial results and report back about the success or failure of the strategy.
For example, let’s say that a company is based in the state of New York, which has a fairly large population, and it’s been doing pretty well with a business product that requires a fair amount of salesperson hand-holding. Management’s new strategy is to roll out the product across the rest of the country. Since it takes a lot of salesperson time to make these sales, it’s a fair bet that initial sales might not be very good in states where the headcount per square mile is fairly low, like Wyoming or Montana. That being the case, it makes sense for the accounting staff to monitor revenue by state, matched up against selling expenses by state. But unless there’s interaction between management and the controller about this strategy, the accounting staff might not even collect revenue and expense information by state, which makes it more difficult for anyone to see if the strategy is going to work.
As another example, a start-up company has to develop software, and it’s projected to take a year before anything is ready for sale. The finance department needs to keep track of how fast the company is burning through its cash reserves, and estimate how many more months the company can last before the cash is gone. For this feedback loop to work, finance needs to be kept aware of the progress of the programming work, and be talking to management all the time about the resources needed to complete the product. That’s the only way to keep management properly informed about how much time is left.
So, what I’ve been talking about so far is accounting and finance being in data collection and feedback mode, where it hands out information about someone else’s strategy. But they can also be involved in the actual formulation of strategy.
Strategy Formulation
Consider the types of strategy that are out there. One of the main ones is cost leadership, where the goal is to be the low-cost provider in the industry, so that the company can set lower prices than anyone else, which allows it to grab market share. To do this, the company has to be incredibly aware of its cost structure at all times, and of what it has to do to lower its costs even more, like building a higher-capacity factory or repositioning its distribution warehouses to minimize distribution costs. And, for that matter, lowering the costs of the accounting and finance departments. Basically, every function in the company has to be figuring out ways to lower costs, because that’s the whole purpose of the company.
Another strategy – and one that applies to a lot more businesses – is differentiation, where the objective is to develop unique products for different customer segments. In this case, accounting can provide input about the cost to develop these products, while finance can weigh in on what the related cash flows are likely to look like. Based on their input, it’s quite possible that management will choose not to pursue products where the market niche is just too small. So in this role, finance and accounting are engaged in something of an advisory role, pointing which options might work better or worse.
And another strategy is blue ocean strategy. I recommend reading the book by the same name – it was released in an expanded edition in 2015, and it originally came out back in 2005. The authors advocate searching for a niche that no one else is serving, and which is new and unique, and then structuring the organization to serve it as perfectly as possible. That’s fine, but the part that relates to finance and accounting is their second recommendation, which is to find unique ways to cut costs by massive amounts, so that the resulting profits are really, really high.
For example, have you ever seen those insurance company cars that come right to your house after a car accident, inspect the damage, and pay you a settlement on the spot? It might seem like they just want to provide great service – well, that might be part of it – but also, consider what just happened from an accounting perspective. They handled the bulk of the accounting for that accident up front. There’s almost nothing left to do, so their total accounting costs just went down.
What this means is that whenever management is considering a radical strategy along the lines of the blue ocean concept, consider whether there’s an entirely different way to handle the associated accounting or finance. Here’s a real-life example from the perspective of finance. Do you remember when touch free car washes were added to the back of practically every gas station in the country? If it seemed like that happened everywhere, all at once, that’s because that’s exactly what happened. I ran across a couple of guys who originally came up with the idea of doing nothing but setting up low-cost leases, so that all of those station owners could afford their own car washes. In this case, it was the financing that drove the entire business model.
And one more example relating to finance. Most people don’t buy the solar panels that are installed on their homes – they lease the panels, because otherwise, they couldn’t afford to buy them outright. In this case, yet again, financing is what drives the entire strategy. Arguably, it supports the entire solar panel business model.
So in short, yes – there is a role for accounting and finance in strategy. Any company should be using them at least as a feedback loop, and in many cases, they can have a surprising amount of input into the formulation of strategy.