Companies are being confronted with a difficult dilemma. On one hand, they need to save cost and restructure their operations due to the economic crisis. On the other hand, they need to invest and innovate to create long-term value for shareholders, clients, employees and other stakeholders. The CFO plays a key role in managing this “business split,” but how should it be done?

Save Costs
Each day brings media reports about businesses that announce cost savings or restructuring plans. All companies – some more than others – are being confronted with the economic crisis and need to take steps to protect profitability or simply survive. This is not a new occurrence; the economy moves in cycles with peaks and valleys during which the weak are separated from the strong. This particular economic downturn is unique because of the unprecedented financial crisis and role of financial institutions.

Create Value
At the same time, companies need to focus on long-term value creation, which applies to listed companies, private equity-owned companies and family businesses. This is easier said than done. Many industries that are being hit hard by the crisis – such as transportation, car manufacturing and construction – are suffering serious cash problems. Businesses in sectors that experience less impact from the recession – such as food or biotechnology – need to take measures to maintain their financial performance and protect their competitive position.

What to Do?
Companies find themselves in “splits” between short-term financial performance and long-term value creation. How should they react? This indeed is a difficult dilemma.  What is the role of the CFO in this situation?

The CFO plays various important roles. On one hand, the CFO needs to ensure and monitor that business operations take place efficiently, loss-making products or activities are being terminated and cost-saving measures are being executed adequately (here the CFO is a “cash guard” and “restructurer”). At the same time the CFO must be watchful so that money is available for innovation and the organization continues investing to strengthening its competitive position (here the CFO is also a “strategist” and “protector”).

Therefore, the CFO is the “financial conscience” of the company. To fulfill such a role and overcome the dilemma, CFOs need to consider the following three options.

Protect the Value Drivers
Companies must have a clear strategy and understand their value drivers. For example, value drivers for a high-tech company are completing a product development project (either creating a new technology or establishing a partnership with a technical university). For a consumer goods company, value drivers are the power of its brands, the superior product quality or the good relationship with its largest customers.

Subsequently, the company should assess to what extent the value drivers are being impacted by the cost savings measures or restructuring plans. If the plans have a positive impact on the short-term financial performance but are harmful for long-term value creation, the company should consider potential adjustments to prevent the value drivers from being hit. During an economic downturn, companies should not save their value drivers but invest in innovation and marketing as an opportunity to make the company more competitive.

Example 1: A measure of a high-tech company to end the hiring of external contractors needs to be adjusted if there are R&D contractors that fulfill a key role in the product development project.
 
Example 2: The decision of a consumer products company to reduce its marketing budget by half results in immediate cost savings but may be a disadvantage for its brands. During a recession, producers of branded products should invest in the differentiation and awareness of the brand image to win share from cheaper (private label) competitors. They also should carefully deal with price adjustments. It is easy to lower price levels at the expense of gross margins to protect market share, but it may be difficult to restore product profitability when market circumstances improve. This can usually only be done with innovative products or strong brands.

The risk here seems clear: decisions being taken that have a harmful impact. But a complementary risk is that the company does not execute its cost-saving measures effectively or timely. Butchers might cut healthy parts, but slow and cautious doctors do not cure the patient.

Improve the R&D Process and Apply a Project Portfolio Approach
The second step is that companies need to improve their R&D process and reassess the costs/potential benefits of their R&D projects. R&D departments are populated with engineers, designers and product developers who focus mainly on the content and show less attention to the development process. For example, if hand-off moments between designers and engineers are not clearly defined and functional and technical specifications are not properly documented or prototypes are not fully tested and evaluated, the final result is sub-optimal due to process flaws.

Additionally, R&D projects should periodically be evaluated from a portfolio perspective: Which projects are we working on? Where do budget overruns occur? Why is progress behind schedule? Why are deliverables and milestones unclear? Allocating funds to projects that have become “hobby projects” or do not have a clear relationship with company strategy and objectives does not create long-term value nor does it contribute to short-term financial performance.

Therefore, the R&D department and product development process should not be excluded beforehand from cost savings initiatives. Process execution should take place in an efficient and effective manner and the projects portfolio should be reassessed periodically. A clearly defined strategy is required, and robust project management and project control are important to monitor and manage the often less than transparent and cash-burning, but essential innovation process.

Find Additional Financing for R&D and Innovation
Debt or Equity?
If it seems inevitable – due to ongoing financial problems – to cut the budgets of valuable innovation projects, then the company should look for additional innovation financing. The CFO plays a key role in this activity within the management team because he or she knows and understands the allocation of the available resources and the possibilities regarding additional financing. Debt providers, such as banks, are usually not the first ones to provide the company with extra funds when adequate collateral is not available and the risk profile is high. Therefore, existing or new shareholders become an important potential provider of additional financing, and the CFO – together with the CEO – should encourage these equity providers to invest in the future of the company. If the liquidity shortage is only provisional, then temporary forms of financing can be applied – such as shareholder loans – providing the opportunity to limit extra shareholder risk.

Consider applying for subsidies from both national and local governments to fund innovation projects. Many companies do not fully exploit these subsidy possibilities due to a lack of knowledge or unclear procedures.  Lastly, CFOs should continuously focus on optimizing working capital. The disposal of unprofitable products or activities that are not considered to be part of the core business can generate extra liquidity.

Shareholders’ Trust
During these challenging times, it is critical that CFOs prevent the company from being forced to cut its value drivers such as innovation, relationships with clients and knowledge partners, the strength of its brands, or the commercial power of the sales department. The key to this is obtaining shareholder trust: the confidence of investors that the company is doing the right thing and is running its business as efficiently as possible. This may be more difficult for listed companies than for private equity-owned companies or family business. The reality is that shareholders of listed companies tend to focus primarily on short-term financial results rather than long-term strategic initiatives.
 
Seize the Opportunities
The economic climate leads to dilemmas but forces companies to get their priorities straight and make clear choices. The current situation also offers opportunities: the changing focus of price-sensitive consumers, possibilities for new products, acquisition of competitors, and restructuring projects that offer the opportunity for process optimization and better prepare the company for the future. Companies that do this and are able to protect and sustain their value drivers can improve their competitive position. Those that make the right decisions and manage their financing needs may come out of the recession as a winner.

The challenge for CFOs is balancing the needs of improving short-term financial performance and enabling long-term value creation. The CFO plays a key role in the allocation of resources and obtaining additional financing. He or she should not only focus on costs and efficiency, but also understand which value drivers the organization needs to protect today in order to win tomorrow. More than ever, the CFO is the right hand of the CEO, the co-pilot who navigates the company through the storm and manages the short-term/long-term dilemma.