Financial decision making in the downturn

Financial decisionmaking in the downturn Foreword Dear reader, It gives me great pleasure to present you with Financial decision-making in the downturn, a report summarising the findings of a survey commissioned by ING Commercial Banking and conducted by the Economist Intelligence Unit As we all know, difficult economic times call for difficult decisions In light of this we were interested in finding out how financial executives in Europe arrive at these decisions, but also hoped there were lessons to be learned for the future We are currently coming through some unprecedented economic times The downturn of 2008 persisted in 2009 as key indicators continued to slide and business and consumer spending shrank With capital becoming more expensive and harder to obtain, many companies found their futures were in the balance Stakes were high and financial decision-makers were forced to make tough choices to guide their company through the turmoil Often they found themselves having to perform a dangerous balancing act On the one hand, to survive you have to look at the near term and ways to navigate the liquidity crisis On the other, while emergency measures may help weather the storm, they not always chime with the company’s long-term performance and strategic objectives These were my own observations in dealing with clients and they were borne out by the findings of the ­Economist Intelligence Unit research study Financial decision-making in the downturn reflects on the thoughts and experiences of senior financial executives and academic experts What were the challenges and how did decision-makers come about resolving short-term issues without jeopardising the company’s long-term future? Or, conversely, did the downturn perhaps make it easier to make difficult long-term strategic decisions? Tough times call for a focused strategy and clear direction That means keeping an eye on the long-term ­picture while facing short-term challenges in a well-considered manner And taking advantage of the situation to make positive changes for the future beyond the turmoil Working together and sharing information is vital if we are to meet the challenges head on It is all too easy to look back and chastise ourselves for the choices we made, especially in difficult times when ­mistakes and failures are magnified And of course there is no guarantee that we will get it right second time around We hope nonetheless that the experiences and views documented in this report provide valuable insights to help you negotiate future hurdles and benefit your company in the long term At ING we know first-hand how an unstable market can affect your finances and how important it is to optimise your balance sheet That’s why we work with you to devise an ambitious and proactive approach to tackle your ­financial issues, whether they relate to working capital, de-risking, shortening your balance sheet or financing future growth In both tough times and when things are picking up, the key is to realize balance sheet optimization in close cooperation with our clients by resolving short-term issues with taking the company’s long term future into account Should you have any questions or comments after reading the report or wish to find out more about what ING can for your business, please feel free to contact me or visit www.ingcommercialbanking.com/bso Kind regards, Annerie Vreugdenhil General Manager Corporate Clients ING Commercial Banking Financial decisionmaking in the downturn In co-operation with the Economist Intelligence Unit Financial decision-making in the downturn Table of contents About the survey Executive summary The long-term view – a key measure of decision quality 12 Cool under pressure 17 Sidebar: Investing in IT at ABB 18 The hazards of hindsight 21 Sidebar: The pre-mortem: Imagining the worst 22 Conclusion – lessons for the next time Financial decision-making in the downturn About the survey ING commissioned the Economist Intelligence Unit to survey 327 UK- and Europebased senior finance executives in October 2009 and write this white paper based on the results More than half of respondents were chief financial officer level or above Half of respondents came from companies with more than €500 million in annual revenues,­and 19% of respondents­came from companies with more than €10 billion in annual revenues All major industries were represented In addition, the Economist Intelligence Unit interviewed 15 senior finance executives and academic experts on decision-making­and the results of these interviews appear throughout the report 7 Financial decision-making in the downturn Executive summary The UK and Europe, like much of the rest of the world, experienced a steep and sustained­economic shock throughout 2008 and most of 2009, from which the region is only now beginning­to recover According to the European Commission, GDP growth for­ the European Union dropped year on year from 2.9% in 2007 to 8% in 2008, and was  projected­to fall 4.1% in 2009, before seeing a modest rise in 2010 Productivity, consumer confidence, industrial production and trade all experienced similar precipitous declines during the same period There were devastating consequences inside European companies First, revenues fell well beyond previous worst-case scenarios, as business and consumer spending shrank significantly Second, the ongoing credit crunch that touched off the crisis made capital more expensive and harder to obtain These twin conundrums put chief financial officers (CFOs) in the eye of the storm, as companies looked to them to cut costs, hastily revise growth forecasts­and renegotiate loans In many cases, as this report demonstrates, the decisions they made determined whether their companies would survive the crisis This paper, based on a survey of 327 senior finance executives and 15 in-depth interviews with CFOs and academic experts, provides a history of the economic downturn from the CFO’s  perspective How did they respond to the high stakes and high pressure of decision-­making­during the crisis, and what lessons can be learned? The research uncovers­the biggest decisions they faced, examines the strengths and weaknesses of the processes and tools they relied on, and asks how successful they were in making short-term, crisis-­driven decisions without sacrificing long-term performance Here are the key findings: The most important decisions revolved around short-term plans to raise cascost cutting, shedding staff and selling assets at the expense of long-term goals CFOs pinpointed their most important decisions in open-ended responses that included “dealing with sudden customer bankruptcies”, “stopping all capital investments”, and “selling assets in Asia and Switzerland” Two-thirds of respondents agreed that important decisions in the midst of the crisis were necessarily focused on the short term at the expense of the long term Asked to compare decision-making with other periods when the economy was growing, 68% said decisions in the recession were primarily focused on immediate­or short-term outcomes, compared with 49% during better times A wise minority took advantage of the turmoil to make positive, long-term changes One-third of respondents claimed to have made their most important decisions with the long­term in mind Examples included “transforming the IT business”, “introducing­ a planning tool for more efficiency and speed” and “streamlining the lead-to-order process”.­Half agreed with the statement, “The downturn gave us the ability to make difficult­ strategic decisions­more easily.” High stakes led to collaboration, a coordinated response and bolder action Two-thirds of respondents said a collaborative process with other senior leaders within their company was the most important factor in making good decisions Forty-two percent­agreed that “contrary views were aired and discussed openly without a culture­ Financial decision-making in the downturn of blame” Respondents said the crisis situation “helped to get buy in”, and drove “bolder action” among management teams Under pressure, CFOs took more time to reflect The majority of respondents agreed that there was more pressure to get decisions right during the downturn, compared with other periods when the economy was growing Two-thirds agreed that the consequences of bad decisions were magnified Rather than letting the pressure rush them into rash action, however, 60% of respondents said they took more time to analyse the options and examine the possible consequences Financial tools performed well but CFOs seek improvement Respondents were in agreement that the tools of their trade such as financial planning, scenario­planning and forecasting were more effective during the downturn For the large majority of respondents, financial IT systems performed the same or better under the added strain Yet when asked what they would most like to improve, many highlighted­the need for better data and modelling Experience breeds confidence, rather than a specific plan Fifty-eight percent of respondents had a senior decision-making role in a previous downturn, and 42% of those with such experience said it was “very useful” The reasons cited were psychological – “diminished tendency to panic”, “to keep calm and not be pessimistic”, and “the ability to cope with pressure and the nervousness of employees” Do the review before the decision Relatively few respondents see any use in a formal process to review decisions after they are taken Experts say this is because of the dangers of hindsight and political­ blame games But they agree that CFOs should persevere with the right kinds of decision­reviews­– which, paradoxically, take place before the decision is made The “pre-mortem”, for example, asks a group of executives collectively to imagine how a decision could go wrong in order to improve­the chances of success 9 Financial decision-making in the downturn The long-term view – a key measure of decision quality The costs of missteps have risen sharply amid the high volatility and poor visibility that have characterised the global financial crisis since it escalated in 2008 In good times, CFOs face important decisions every day, but they are more often choices related to growth and the strategies to achieve it – where to invest, which companies to acquire and where in the world to expand During the downturn the biggest decisions often related to whether the business would survive at all The low point for Roularta Media Group, a Belgian media company, came when it was at risk of breaching several debt covenants “Banks would have taken over the company,” says Jan Staelens, the CFO As a result, most CFOs focused on short-term outcomes, and their most important decisions involved raising­­cash Please identify the top three areas in which you made your most important decisions during the last 12-18 months? (Respondents were allowed to choose their top three answers.) Cost control (excluding personnel decisions) 46% Cost control (personnel decisions only) 45% Forecasting and budgeting 43% Working capital management 33% Payments and cash management 31% Restructuring 22% Risk management 21% Refinancing (revising existing agreements) 13% 10 20 30 40 50 60 70 80 90 100 % Striking the balance between short-term outcomes and the long-term strategy is far from easy, of course, especially in turbulent economic conditions, but it is a key yardstick for decision quality, according to Daniel Kahneman, Nobel Prize-winning professor of psychology and public affairs emeritus at Princeton University in the US, and one of the experts interviewed for this report Even short-term decisions, he says, can “maintain some long-term perspective in the corner of the eye,” to view, for example, “a decision about restructuring as an opportunity There are many ways of cutting costs and some are more detrimental to the long term than others The interesting question would be, when they were cutting costs, how conscious were they of the long-term implications?” How well then did CFOs perform in this critical area? Sixty-eight per cent of executives say their most important decisions in the last 12-18 months were focused on immediate­ or short-term outcomes, compared with 49% in better economic times And 65% say that short-term decisions were made at the expense of the long term Seventy-six percent say their ability to focus on long-term targets was somewhat or significantly affected­by the pressure of the downturn 10 Financial decision-making in the downturn “We have unfortunately prioritised short-term goals over longer-term goals,” says one CFO “There are some capex investments, which we did not make, which will hurt the business in the medium to long term.” Many business leaders are in a similar situation, notes Neil Bearden, assistant professor of decision sciences at INSEAD business school in France Executives in crisis, he points out, exhibit similar behaviour to investors in a bear market “They respond to minor losses at the expense of long-term planning,” he says “They see something is going wrong and they cut costs to keep earnings going Many who did that are now seeing where they took short-term decisions that they have to unwind.” Please indicate which of the following best describes­your important decisions for the last 12-18 months and for other periods when the economy was growing? Last 12 - 18 months 33% Other periods when the economy was growing 53% 51% 10 20 30 15% 40% 40 50 60 70 9% 80 90 100 % Important decisions primarily strategic: (focused on long-term outcomes) Important decisions primarily tactical: (focused on short-term outcomes) Important decisions primarily “in the moment”: (focused on immediate outcomes) How did the pressure of the downturn affect the following processes you took to reach important decisions? Ability to focus on long-term targets 24% 10 46% 20 30 40 50 30% 60 70 80 90 100 % Didn’t affect at all Somewhat affected Significantly affected Opportunity in crisis The survey and interviews reveal that most CFOs felt that they had no choice but to focus on immediate outcomes But for about one-third of respondents, the turbulent environment opened up opportunities – to make acquisitions, strengthen relationships with vulnerable suppliers or customers, or to make the most of the low-growth environment to invest in enterprise-wide IT systems that may secure longer-term operating efficiencies Half of respondents, presumably even some who were primarily focused on the short term, agreed with the statement, “The downturn gave us the ability to make difficult strategic decisions more easily.” 11 In reflecting on your most important decisions during the last 12-18 months, to what extent do you agree or disagree with the following statements? Financial decision-making in the downturn Because of the nature of the threat facing the business, important decisions necessarily focused on the short term at the expense of the long term 22% The consequences of incorrect decisions were magnified in the downturn 25% The downturn meant there was less time for reflection on important decisions 13% Mistaken decisions were tolerated less at all levels of the organisation 12% The elements that go into good decisions are well understood but under the circumstances they were difficult to apply effectively 3% Important decisions were hampered by over-confidence and a tendency to “hope for the best” 40% 10 20 30 7% 3% 39% 13% 5% 18% 24% 13% 28% 50 2% 16% 23% 40 7% 16% 30% 34% 8% 38% 25% 28% 16% 23% 30% 21% 13% 25% 40% 12% The downturn gave us the ability to make difficult strategic decisions more easily 15% 40% 6% There was hesitation in taking big decisions because of the high stakes involved 43% 60 16% 70 80 90 6% 100 % strongly agree slightly agree neither agree nor disagree slightly disagree strongly disagree A case in point is Millicom International Cellular The Luxembourg-based mobile telephony operator last year analysed its operations in Asia, Africa and Latin America, including market position, return on capital and expected investment requirements Subsequently, managers chose to dispose of the Asian operations “One thing that played a key role in our decision was: Where we believe that we can better use and deploy our limited resources?” says François-Xavier Roger, the CFO “The single most important factor to make the sale was most certainly our capacity to create shareholder value over the long term.” Another case in point is provided by a finance executive at a large chemicals company who asked to remain anonymous He said his most important decision involved creating a plan to avoid breaching loan covenants “We aimed to solve the short-term issue, but we also built a new financing structure, including new covenants, in order to cope with what we see as a recovery in the economy, which will hopefully allow us to ‘live quietly’ (without negotiations with banks), until 2012.” An important lesson, says Theodoros Evgeniou, associate professor of decision sciences and technology management at INSEAD, is to take a “positive view of crisis and turbulence”, as difficult as that sounds “Let’s fire-fighting,” he says, “but also look for the best opportunities in history.” 12 Financial decision-making in the downturn Cool under pressure A majority of CFOs say that the pressure to get decisions right increased during the crisis, and respondents are forthright about many of the reasons: “not enough time and data”, “the need to get board approvals and address differing views”, “it affected personal emotions­”, or “answers needed more quickly” Moreover, they agree that the consequences of bad decisions were magnified in the crisis Far from crumbling under the strain, however, CFOs seem to have been, broadly speaking, invigorated by the crisis This may reflect executives’­perception that the top finance role is a high-pressure job even in the best of times After all, a surprising 46% say they felt no added pressure at all on their decisions over the last 18 months Mr Staelens of Roularta says he joined precisely because he welcomed the challenge of attempting­to extricate the company from its covenant problems “I was attracted to the company to get it right,” he says Others echoed his enthusiasm, and the response to admittedly­higher pressure seems to have manifested itself in better collaboration, more effective­IT tools and an emphasis on the value of experience gained in past recessions Did you feel more pressure to get important decisions right during the past 12-18 months, when compared with other periods when the economy was growing? No, there was about the same amount of pressure to get important decisions right 46% Yes, there was a little more pressure to get important decisions right 27% Yes, there was a lot more pressure to get important decisions right 26% 10 20 30 40 50 60 70 80 90 100 % Fighting a common enemy This research shows that when the going got tough, it helped focus the enterprise Nearly 70% of executives surveyed say that collaborative processes with other senior leaders are the single most important factor in making financial decisions Viquar Haquani, CFO of Radiomóvel Telecomunicações, a Portuguese mobile telephony operator, is one of those executives “We have a small, collegial team We are very open with each other, and we speak freely,” he says “At times, that can be a little bit heated – but we find it very useful.” Michel Allé, CFO of Belgian National Rail, concurs: “The most important lesson is to tell the truth as soon as possible, even if it’s bad news When I was open with the board and with shareholders, they responded well.” A collegial environment is conducive to frank discussion Finance executives generally say that their decision-making processes worked well when it came to contrary views This may reflect the fact that options were limited Forty-two per cent say “contrary views were aired and discussed openly without a culture of blame” and 35% say there was a “clear, formal process to gather and decide among contrary views” Only a minority say it was dangerous to air contrary views, or that such views were overruled Toby Wilson, Microsoft’s UK finance director, points out: “The most difficult part was not making the decision itself, but agreeing the process for implementing the decision Once this had been put in place, the rest was fairly straightforward.” 13 Financial decision-making in the downturn CFOs also called on external advisers to complement analysis carried out internally One example is Carmeuse, a Belgian limestone producer To help the firm plan its response to the developing crisis, Yves Schoonejans, the CFO, directed an external adviser­to analyse the impact of tougher economic conditions on the firm’s main customers such as the steel industry, and the steel industry’s main customers such as automotive manufacturers and construction firms Some CFOs say they had formed a view internally, but given the higher stakes and greater scrutiny from stakeholders, sought external opinions to validate their position Millicom, for example, sought outside advice before pushing ahead with the sale of its Asian operations “We made the decision ourselves, but it’s always good to listen to the opinion of various people in the market, who have a different view or a different expertise than we may have,” says Mr Roger CFOs’ appetite for reflection went up too Sixty per cent of those surveyed say they took more time to make important decisions than in more normal times The reasons? Respondents say they used the extra time to conduct more rigorous analysis, have deeper discussions with board colleagues, consult more widely than usual and scrutinise­every available option far more closely When you made important­decisions during­the last 12-18 months, which of the following­factors helped you the most? (Respondents were allowed­to choose their top three answers.) Collaborative process with other senior leaders 68% Clear lines of command in the organisation 42% Deep, applicable experience 39% Good intuition 30% Hearing contrary views 24% Personal networks 22% IT systems 20% 10 Which of the following statements apply to your ability to gather contrary views and stimulate internal­debate before an important decision? There was often no time to gather contrary views before a big decision was taken 20 It was politically dangerous to air contrary views 40 50 60 70 80 90 100 % 50 60 70 80 90 100 % 21% There was a clear, formal process to gather and decide among contrary views Contrary views tended to be overruled 30 35% 17% 13% Contrary views were aired and discussed openly and without a culture of blame 42% 10 20 30 40 14 Which of the following best describes the amount of time you needed or were required to take to make your most important decisions during­the past 12-18 months, compared with other periods when the economy was growing? Financial decision-making in the downturn I took a lot more time to make important decisions compared with other periods when the economy was growing 29% I took a little more time to make important decisions compared with other periods when the economy was growing 31% I took about the same amount of time to make important decisions compared with other periods when the economy was growing 28% I took a little less time to make important decisions compared with other periods when the economy was growing 9% I took a lot less time to make important decisions compared with other periods when the economy was growing 3% 10 20 30 40 50 60 70 80 90 100 % Investments in IT pay off Most CFOs say they were happy with the performance of their in-house enterprise software systems during the downturn In particular, they pointed to the added agility that these systems offer executives when making decisions Michel Demaré, CFO of ABB, a Swiss power and automation firm, says that the efficiency of his firm’s management information system freed up time for executives to plan, forecast and act (See sidebar, this section.) Fifty-two per cent of respondents agree that their scenario planning has been more effective in the last 12-18 months than in previous periods of growth; 48% found financial planning more effective, and 48% found sensitivity analysis more effective Forecasting received a high positive score, with 44% of executives reporting that it has been more effective in the last 12-18 months However, forecasting also received the greatest negative rating among finance executives, with 27% saying that it was less effective, reflecting, perhaps, the difficulty of forecasting accurately in times of turbulence Even though financial IT systems were under added pressures, most respondents say they performed similarly to other periods when the economy was growing, and 28% say they performed better Overall, it is evident that previous investment in financial information systems paid dividends during the depth of the downturn How would you rate the quality (in terms of time­liness, accuracy and relevance)­of information­ you received from financial IT systems (spreadsheets, performance management programmes, etc) during the last 12-18 months, compared with other periods when the economy was growing? A lot higher quality 6% Some what higher quality 22% About the same Some what lower quality A lot lower quality 62% 8% 2% 10 20 30 40 50 60 70 80 90 100 % 15 How effective or ineffective were the following tools during the last 12-18 months, when compared with other periods when the economy was growing? Financial decision-making in the downturn Financial planning (ie, quantifying the impact of a business decision on the balance sheet and income statement) 14% 34% Forecasting 14% 30% Process mapping Data mining 5% 9% 5% 1% 37% 28% 20% 18% 52% 6% 2% 15% 4% 18% 50% 7% 4% 17% Simulation models 7% 33% 14% 5% 16% Risk and variance models 9% 25% 31% Scenario planning 13% Sensitivity analysis 14% 10 32% 10% 4% 14% 39% 32% 34% 20 30 35% 40 50 A lot more effective Somewhat more effective About the same Somewhat less effective A lot less effective Don’t know/not applicable 2% 9% 60 70 80 7% 2% 8% 8% 1% 9% 90 100 % 16 Financial decision-making in the downturn A psychological boost Nearly 60% of respondents had experience of previous downturns in a management role, and of those 51% said the experience was somewhat useful and 42% said it was very useful The benefit of the experience is psychological as well as practical Typically, CFOs say that their experience helped maintain calm among colleagues, and inspire confidence in themselves and their colleagues “Knowing that the world had not come to an end despite what the newspapers said,” cited one CFO “I took decisions earlier by forecasting scenarios that other people couldn’t believe were possible,” said another Hand in hand with experience comes intuition While many finance executive say they relied heavily on data from internal and external sources, and on other facts, some say that the financial crisis was an opportune time to question the conclusions to which the facts seemed to point “There is a bit more room to look behind figures, and to say ‘OK, this is what the figures tell us, but what is [really] happening around us?’” comments­Werner De Laet, CFO of Mobistar, a Belgian mobile telephony operator.­ However, facts remain the most important element on which executives base their decision,­ as Boudewijn Beerkens, CFO of Wolters Kluwer, a Netherlands-based media­ and information company, points out “Intuition is nothing more than an undefined culmination­of tough experiences,” he says John Deverell, head of global security at Invensys, a UK technology group, and a 33-year veteran of the British Army, says that in both military and business situations intuition is supported by repeatable processes that can be employed in a crisis “When you come up against the enemy, there’s a sequence of very straightforward questions you ask in order to come to a simple, templated decision of attack,” he explains “The training is about being confident with the process, and repeating it, with variations to suit the exact situation Intuition is an accumulation of experiences from previous decision-making.” How effective or ineffective were the following tools during the last 12-18 months, when compared with other periods when the economy was growing? Yes, and my experience of previous downturns was very useful Yes, and my experience of previous downturns was somewhat useful Yes, and my experience of previous downturns was little or no use 25% 30% 4% No, I didn’t have experience of prior downturns 42% 10 In thinking about the one to three most important decisions you took during the last 1218 months, which statement best characterises the way you ultimately decided? 20 30 Gut feel played a role, but decided based on facts 50 60 70 80 90 100 % 50 60 70 80 90 100 % 45% Fact-based, but decided on ‘gut feel’ 32% Mainly based on facts Mainly based on ‘gut feel’ 40 20% 3% 10 20 30 40 17 Financial decision-making in the downturn Investing in IT at ABB In 2002 ABB, a Swiss power and automation technologies firm, was close to the abyss Burdened by the prospect of huge payouts to settle asbestos claims, and under a mountain of short-term debt, the firm was weeks from bankruptcy Against the odds, ABB came back from the brink This time round, as the financial and economic crisis deepened in the course of 2008, ABB’s prior experience helped management to act decisively First, as part of a strategy to set the firm on a stronger footing after 2002, management­had made substantial investments in enterprise resource planning (ERP) “We had all these decentralised units working on different systems that didn’t talk to each other,” says Michel Demaré, the CFO “Five years ago, I think it would have taken us much more time to collect data, clean it up, and stop arguing about the quality Thanks to that we have more time to plan, to forecast and to take measures, rather than just collect data.” Second, ABB management did not hesitate to turn processes on their head “There are a lot of processes that you have to really simplify to gain agility,” explains­Mr Demaré For example, the firm’s lengthy bottom-up budgeting process­had started in the summer of 2008 – with hundreds of business units putting their budgets together But during that time, the financial crisis deepened Given the rapidly changing environment, ABB management scrapped the bottomup­budget in favour of a top-down approach “We decided that the world was changing so fast that we needed to switch,” Mr Demaré recalls 18 Financial decision-making in the downturn The hazards of hindsight Exactly one-half of those polled for this report agree that the decisions they made would have had better outcomes if they had been made sooner But many executives, understandably, say they acted with the best information they had at the time, and that in practical terms they could not have acted any earlier Mr Roger of Millicom says of his firm’s divestment: “Maybe it would have been better six months ago, but maybe it would have been better in a year.” As he points out, though, “there was no evidence at the time that the sky would be blue in two years.” When asked how they could have made better financial decisions during the downturn, some executives responded wistfully, “with a crystal ball.” In a more realistic vein, others wished they had understood the severity earlier and acted accordingly “One barrier to learning is that all of a sudden in hindsight it was clear what they should have done,” says Dr Bearden of INSEAD “Because it’s so clear, they think it would be reasonably transparent the next time.” “When thinking about your most important decisions during the past 12-18 months, which of the following applies?” The outcome would have been better if the decisions had been taken earlier The outcome would have been better if the decisions had been taken later 50% 6% The outcome would have been better if the decisions had been deferred indefinitely (ie, no action taken) 2% The timing led to the best possible outcome Don’t know 31% 11% 10 20 30 40 50 60 70 80 90 100 % Some firms have a framework for evaluating decisions when they revolve around a specific­programme such as a new marketing initiative or product line “We tend to look at the most critical ones,” says Mr De Laet of Mobistar “After we have launched a product,­it’s done mainly from a financial and marketing point of view, to check if the financial, business and market assumptions were the right ones.” Mr De Laet adds that he feels the process is not done often enough, and that the structure could improve But companies that formally gauge the effectiveness of decisions are in the minority Just 34% of executives say their firms had a formal process in place to review the quality­ of decision-making in the past 12-18 months Some CFOs say, simply, that the stock price is an accurate reflection of the outcome of management decision-making Mr Roger of Millicom points out that after divesting its Asian business, the firm has several options for measuring the effectiveness of the decision “One is to look at what the new owners will with the assets,” he says, “and compare its performance with the performance we had expected internally.” On the other hand, however, Mr Roger questions whether there’s value in such an exercise “The decision has been made, the deal has been executed,” he says, “so there is little point in looking [back].” 19 Financial decision-making in the downturn Professor Kahneman of Princeton University explains why that approach often prevails in organisations “Any formal review process threatens the decision-makers, threatens them with possible hindsight,” he says For his part, Dr Evgeniou of INSEAD also stresses the need to review financial decisions “Stick with learning processes and review processes,”­ he says “Stick with them even though you may think there is nothing to learn You get tricked by the hindsight bias That is a mistake Executives should understand that you have quality control on the process, not necessarily on the outcome As long as the decisions­they took are the result of a solid decision process, it’s good.” Which of the following best describes the process in place for evaluating the quality of decisions taken during the last 12-18 months and for other periods when the economy was growing? Last 12 - 18 months 31% Other periods when the economy was growing 34% 36% 10 20 34% 31% 30 40 50 33% 60 70 80 90 100 % No decision quality review process in place We have a formal process to review the quality of decision-making Decision quality is reviewed indirectly (ie, on an ad hoc basis and according to whether targets are reached) 20 Financial decision-making in the downturn Maintaining momentum Whether or not firms track the effectiveness of decisions, CFOs hope to keep building on successes Carmeuse, for instance, plans to keep in place the work that it has done in the past two years to sharpen up its forecasting and planning processes “We went into a significantly greater level of detail than we normally do, and we have improved the process quite significantly,” says Mr Schoonejans, the CFO “One positive aspect of that is that we can keep the same level of detail, moving forward It is something that we will capitalise on for the future.” Finance executives are crystallising what they have learned in other ways While many CFOs have pointed out the benefits of sophisticated IT systems during the downturn, our survey and interview programme suggest that the downturn has also strengthened many executives’ resolve to invest in their information systems Thirty-eight per cent plan to improve financial planning, while 39% plan to improve forecasting Moresophisticated­data tools, for example, may help executives anticipate trends sooner, and act more decisively And what about those finance executives that have made decisions that will turn out – with hindsight – to have been wrong? Taking further, tough decisions may be needed Cees van Rijn, CFO of Nutreco, a Netherlands-based producer of animal feed, has admiration for executives who have the mettle to divest businesses they themselves have acquired, but which have proven a poor choice “Everybody will have, in their career, made a wrong acquisition that will need to be divested after a couple of years,” he says “That’s life.” Have you made improvements or you plan improvements in any of the following areas? Financial planning (ie, quantifying the impact of a business decision on the balance sheet and income statement) 17% 42% 38% 2% 2% Forecasting 17% 41% 39% 1% 2% Process mapping 25% 22% Data mining 26% 19% Monte Carlo simulation (ie, injecting random data into a model to measure the impact of uncertainty on the outcome of a project) 36% Scenario planning 23% Sensitivity analysis 23% 10 32% 33% 7% 11% 4% 29% 30 40 18% 3% 18% 42% 33% 36% 20 3% 25% 50 60 70 2% 14% 2% 13% 80 90 No improvements planned Improvements already made Improvements planned Will eliminate or severely downgrade their role in future decision-making Don’t know/not applicable 100 % 21 Financial decision-making in the downturn The pre-mortem: Imagining the worst It may come as little surprise that, among CFOs surveyed for this report, many say hindsight would have come in handy as they grappled with the dilemmas posed by the financial and economic crisis That’s a tall order, of course The next best thing, perhaps, is prospective hindsight – imagining that an event has already happened Gary Klein, a US-based decisionmaking research psychologist, has built on the potential of prospective hindsight with his so-called Investing in IT at ABB process for decision-makers Many new projects, investments and decisions are destined from the outset to fail In part, this is down to the fact that colleagues are sometimes reluctant to voice doubts about a project By creating a formal framework for expressing any concerns during the project planning phase, management may improve the chances of  a project succeeding The pre-mortem creates exactly this framework It is scheduled during the planning stages of the project, investment or decision A team of colleagues is briefed on the planned project – and finally asked to imagine that, after implementation, the project has turned out to be a spectacular disaster for the company Those present are asked to write down a short history of that disaster The imagined scenarios that result are then collated The pre-mortem’s prospective hindsight has a number of benefits For one thing, the approach helps managers to spot potential obstacles early on, before the plan is implemented For another, it acts as a counter-balance to the emotional investment that management often has in a project And finally, the pre-mortem sensitises colleagues to any early signs of trouble if they emerge later on According to one US academic study, prospective hindsight increases the probability of correctly identifying the reasons for a future outcome by 30% For those making financial decisions, conducting a pre-mortem may away with the need to carry out a post-mortem later 22 Financial decision-making in the downturn Conclusion – lessons for the next time Recessions have come and gone since capitalism began, but this one was different in two respects, according to the executives and experts we interviewed: its global scope and the speed at which the business environment almost everywhere deteriorated.­ “The size of the crisis made it harder than any of the other previous ones in my professional­experience,” said one CFO “There was much more systemic risk, adds Dr Evgeniou of INSEAD “You had to have a systemic view of things, not only on your industry but on others such as the real estate industry and the banking industry.” His colleague at INSEAD, Dr Bearden, agrees, but cautions: “Treating this crisis as new might make us forget principles that go back to the Greeks.” Certainly CFOs will be reviewing their risk management strategy, capital structure and approaches to cash and working capital, and all of that will be beneficial But what about the quality of decisionmaking itself? What lessons has this research taught us that could be applied to the next crisis, whenever it may happen? • Take the long view even when it is difficult: Some two-thirds of executives in this research admitted they made decisions with short-term outcomes in mind, even if they were aware that these would turn out to be detrimental in the future Sometimes pressure­from shareholders demands action But about one-third of respondents said they did not sacrifice the long term They chose actions that cut costs and made strategic­sense, such as letting go of a chronically underperforming unit They took more time to reflect, even under severe pressure for action, and reserved some part of the eventual decision to reset the company strategy over the long haul • Strengthen personal ties within the management team and rally around a cause: Collaboration was the most important factor for good decision-making The consequences of potentially going out of business or making redundancies led to more focus and agreement on objectives Executives should try to maintain that common­sense of purpose as the recovery begins • Invest in a ‘crystal ball’: A near-death experience a decade ago forced ABB in Switzerland­to invest in a new financial IT system that gave managers the data they needed to navigate through this downturn Respondents overwhelmingly said if they could change one thing it would be the quality of their data The challenge of course is proving­that more spending is needed—just at a time when cost cuts are in fashion and new capital investment is viewed with a more sceptical eye than ever • Review the process, not only the outcome: Reviewing only outcomes can be counter- productive if managers feel threatened with perfect hindsight Preferably decision reviews­will focus on whether decision processes were right These can even take place before the decision is made, through innovative ideas such as the “pre-mortem” Such reviews, says Dr Evgeniou of INSEAD, can’t guarantee great decisions every time, “but they will work better than just focusing on outcomes.” To download the digital version of the research, go to: www.ingcommercialbanking.com/insights [...]...11 In reflecting on your most important decisions during the last 12-18 months, to what extent do you agree or disagree with the following statements? Financial decision- making in the downturn Because of the nature of the threat facing the business, important decisions necessarily focused on the short term at the expense of the long term 22% The consequences of incorrect decisions were magnified in the. .. 80 90 100 % 15 How effective or ineffective were the following tools during the last 12-18 months, when compared with other periods when the economy was growing? Financial decision- making in the downturn Financial planning (ie, quantifying the impact of a business decision on the balance sheet and income statement) 14% 34% Forecasting 14% 30% Process mapping Data mining 5% 9% 5% 1% 37% 28% 20% 18%... No decision quality review process in place We have a formal process to review the quality of decision- making Decision quality is reviewed indirectly (ie, on an ad hoc basis and according to whether targets are reached) 20 Financial decision- making in the downturn Maintaining momentum Whether or not firms track the effectiveness of decisions, CFOs hope to keep building on successes Carmeuse, for instance,... performance with the performance we had expected internally.” On the other hand, however, Mr Roger questions whether there’s value in such an exercise The decision has been made, the deal has been executed,” he says, “so there is little point in looking [back].” 19 Financial decision- making in the downturn Professor Kahneman of Princeton University explains why that approach often prevails in organisations... Improvements planned Will eliminate or severely downgrade their role in future decision- making Don’t know/not applicable 100 % 21 Financial decision- making in the downturn The pre-mortem: Imagining the worst It may come as little surprise that, among CFOs surveyed for this report, many say hindsight would have come in handy as they grappled with the dilemmas posed by the financial and economic crisis... was not making the decision itself, but agreeing the process for implementing the decision Once this had been put in place, the rest was fairly straightforward.” 13 Financial decision- making in the downturn CFOs also called on external advisers to complement analysis carried out internally One example is Carmeuse, a Belgian limestone producer To help the firm plan its response to the developing crisis,... with other periods when the economy was growing? Financial decision- making in the downturn I took a lot more time to make important decisions compared with other periods when the economy was growing 29% I took a little more time to make important decisions compared with other periods when the economy was growing 31% I took about the same amount of time to make important decisions compared with other... capitalise on for the future.” Finance executives are crystallising what they have learned in other ways While many CFOs have pointed out the benefits of sophisticated IT systems during the downturn, our survey and interview programme suggest that the downturn has also strengthened many executives’ resolve to invest in their information systems Thirty-eight per cent plan to improve financial planning, while... control on the process, not necessarily on the outcome As long as the decisions­they took are the result of a solid decision process, it’s good.” Which of the following best describes the process in place for evaluating the quality of decisions taken during the last 12-18 months and for other periods when the economy was growing? Last 12 - 18 months 31% Other periods when the economy was growing 34% 36%... place to review the quality­ of decision- making in the past 12-18 months Some CFOs say, simply, that the stock price is an accurate reflection of the outcome of management decision- making Mr Roger of Millicom points out that after divesting its Asian business, the firm has several options for measuring the effectiveness of the decision “One is to look at what the new owners will do with the assets,” he ... or ineffective were the following tools during the last 12-18 months, when compared with other periods when the economy was growing? Financial decision- making in the downturn Financial planning... with the following statements? Financial decision- making in the downturn Because of the nature of the threat facing the business, important decisions necessarily focused on the short term at the. .. planned Will eliminate or severely downgrade their role in future decision- making Don’t know/not applicable 100 % 21 Financial decision- making in the downturn The pre-mortem: Imagining the worst It