Editor’s note

Role of the CFO :

The role of the finance executive is evolving and expanding at a rapid

Selected readings for

pace. Today, CEOs turn to their finance teams for everything from setting
productivity standards to driving board effectiveness to acting as de facto
VCs for growth initiatives. Additionally, CFOs are increasingly called upon

finance leaders
to help shape and implement their companies’ strategies, and to play
stronger roles in corporate portfolio management and capital allocation.
Financial reporting, audit and compliance, treasury and capital structure?
Yes, those are all part of job, too.

In short, those who want to become finance leaders need to prepare for a
difficult and evolving role. Their skills need to span core finance functions
and thought leadership, but they must also act as counsel and catalyst,
bringing fresh eyes to company strategic questions and fearless questions
to entrenched beliefs. Meanwhile, most organizations are struggling to
2016 match the capabilities of their existing finance teams with the skills their
Ankur Agrawal
businesses need to create value. As a result, they’re increasingly seeking
Principal,
executives with deep experience outside the traditional finance and
New York office
accounting careers.

Over past several years we have worked closely with several finance
teams to prepare them for their expanding role and needed capabilities
in effectively driving value creation at companies. In this booklet, we have
compiled a series of articles excerpted from our McKinsey on Finance
journals and McKinsey Quarterly to share some of our insights on five
Ishaan Seth
important themes related to the finance function today. They include
Senior partner,
the principles of value creation – an area in which financial executives
New York office;
have extensive influence – and lessons for performance transformations
Global Leader
(including tips from a veteran turnaround artist). The articles also cover
Finance Service Line
ways to eliminate biases from decisions about resource allocation, and to
lead high-performance finance teams.

Critically, we examine what it means to be a CFO today, based on an

Robert Uhlaner
Senior partner,
San Francisco office;
Global Knowledge Leader
Corporate Finance Practice
analysis of the experiences, credentials and backgrounds of CFOs of
the Top 100 global companies. This research can be a useful tool for
benchmarking your own experience and identifying both your strengths
and gaps.
Any executive aspiring to the CFO role will need to develop a perspective
on these critical elements of the finance function role. We hope you will
find these articles useful.

1 Role of the CFO: Selected readings for finance leaders

Editors’ note

The role of the finance executive is evolving and expanding at a rapid

pace. Today, CEOs turn to their finance teams for everything from setting
productivity standards to driving board effectiveness to acting as de facto
VCs for growth initiatives. Additionally, CFOs are increasingly called upon
to help shape and implement their companies’ strategies, and to play
stronger roles in corporate portfolio management and capital allocation.
Financial reporting, audit and compliance, treasury and capital structure?
Yes, those are all part of job, too.

In short, those who want to become finance leaders need to prepare for a
difficult and evolving role. Their skills need to span core finance functions
and thought leadership, but they must also act as counsel and catalyst,
bringing fresh eyes to company strategic questions and fearless questions
to entrenched beliefs. Meanwhile, most organizations are struggling to
match the capabilities of their existing finance teams with the skills their
businesses need to create value. As a result, they’re increasingly seeking
executives with deep experience outside the traditional finance and
Ankur Agrawal
accounting careers. Finance leaders with knowledge of data science,
Partner
M&A strategy, disruptive business models, cyber issues and cloud
New York office
services will be in particular demand.

Over the past several years we have worked closely with several finance
teams to prepare them for their expanding role and needed capabilities
in effectively driving value creation at companies. In this booklet, we have
compiled a series of articles excerpted from our McKinsey on Finance
and McKinsey Quarterly journals to share some of our insights on several
Ishaan Seth
important themes related to the finance function today. They include the
Senior Partner
principles of value creation – an area in which financial executives have
New York office
extensive influence – and ways to eliminate biases from decisions about
Global Leader
resource allocation. The articles also cover the re-emergence of Zero-
Finance Service Line
based budgeting, and how to lead high-performance finance teams.

Critically, we examine what it means to be a CFO today, based on an

analysis of the experiences, credentials and backgrounds of CFOs of
the Top 100 global companies. This research can be a useful tool for
benchmarking your own experience and identifying both your strengths
Robert Uhlaner and gaps.
Senior Partner
San Francisco office Any executive aspiring to the CFO role will need to develop a perspective
Global Knowledge Leader on these critical elements of the finance function role. We hope you will
Corporate Finance Practice find these articles useful.

1 Role of the CFO: Selected readings for finance leaders

 Contents

22

What does it mean to be CFO?

03 04 Which profile best suits your company
10 Rethinking people development in finance
14 Profiling the modern CFO: A panel discussion
20 The Strategist CFO: A conversation with ADP’s Jan Siegmund
Today’s CFO: Which profile 25 Building a better partnership between finance and strategy
best suits your company?
McKinsey on Finance
Profiles of today’s CFO show how the role is evolving and raise important questions

Principles of value creation

for boards about talent and leadership development.

29
Ankur Agrawal, Most readers are well aware that the role of the board—through the audit committee—shape a
John Goldie, and CFO generally has broadened over the past decade. manageable profile for the position? It’s an
Bill Huyett
Beyond the core responsibilities of financial important question, both for companies hiring a
reporting, audit and compliance, planning, treasury,
and capital structure, many CFOs are playing
a stronger role in corporate portfolio management
new CFO and for existing CFOs who see their roles
expanding without a broad perspective. 30 How to choose between growth and ROIC
34 Are you still the best owner of your assets?
and capital allocation. Others have become To get a more detailed picture of how the role
prominent as the voice of the company in investor continues to evolve, we analyzed the experience,
relations and in communications to the board, credentials, and backgrounds of CFOs of the
as leaders in performance management, and as top 100 global companies by market capitalization.1
exporters of finance-experienced personnel Our review, while not definitive, suggests that
Perspectives on How to improve strategic planning 1
to the rest of the organization.
Corporate Finance It can becompanies are shaping
a frustrating exercise, but there the roletoto
are ways meetitstheir
increase value. cur-
and Strategy
Marketrent needs. Indeed,
fundamentals: we identified
2000 versus 2007 8 four distinct
Where does it end?Number
It’s unproductive
25, Whither profiles
to stretch the the S&P 500?
of Comparing the market’s
the role defined byrecent
theturmoil with of
breadth its decline
the
Autumn 2007 at the end of the dot-com boom can help investors assess what might come next.

Applying lessons learned from restructuring

role too far and unreasonable to expect a CFO to be current CFO’s experience in finance or in
When to break up a conglomerate:
good at everything. How can the CEO and the nonfinance
An interview functions;
with Tyco his orCFO
International’s her 12
professional focus,
Chris Coughlin explains how spinning off some of the company’s largest
9
businesses was the key to ensuring its long-term growth.
How to choose between growth and ROIC 19
Investors reward high-performing companies that shift their strategic focus
prudently, even if that means lower returns or slower growth.

40 41 Maintaining a long term view in turnarounds

46 Leading companies out of crisis: Ten tips from a veteran turnaround artist
© Dennis O’Clair/Corbis

52 Can we talk? Five tips for communicating in turnarounds

M A R C H 2 012

Maintaining a long-term view

during turnarounds

Dynamic resource allocation and eliminating

Changing course demands an intense focus on short-term performance, but
success needn’t come at the expense of long-term value.

bias in decision-making
Kevin Carmody, Peter switched on his desk lamp. It was getting a weak economy, the reduction in operating

57
Ryan Davies, and dark, and the past 11 hours had been full of
Doug Yakola
meetings and decisions. His trucking company
had been struggling with the high diesel prices
and soft economy of the early 2000s, but he had
been fighting back by cutting costs across
the board. He wasn’t failing yet, but he wasn’t
s t r a t e g y p r a c t i c e sure how long he could fend it off.
costs would be welcome—and he’d be positioned
well to compete when the economy picked up.
But as he stared at the numbers, he now wondered
if it would still be the right move. The switch
to natural gas would require a host of difficult
organizational and operational changes—
even if some of them would free up much-needed
cash. He put down his pen and closed the file.

How to put your

He opened an approval request on his desk for What he really needed, he realized, was a way to

58 How to put your money where your strategy is

the second time that week and read it again. more fundamentally turn things around.
It was a multimillion-dollar purchase order for
retrofitting his entire fleet to natural gas. Any leader who’s been through a turnaround
Several months earlier, the decision had seemed knows that driving one requires an intense

69 Overcoming a bias against risk

to be a no-brainer: his trucks could run on focus on delivering near-term results. Some moves

money where your

Joanna
natural gas for a Barsh, Josephine
fraction of the cost of diesel. In make obvious sense. Building value-creation

Mogelof, and Caroline Webb

How centered 74 Zero-based budgeting: Five myths and realities

strategy is leaders achieve 78 The return of zero-base budgeting

Stephen Hall, Dan Lovallo, and Reinier Musters extraordinary

results
Most companies allocate the same resources Centered Leadership
to the same business units year after
year. That makes it difficult to realize strategic
goals and undermines performance.
82 83 How centered leaders achieve extraordinary results
Here’s how to overcome inertia.
Artwork by Gwenda Kaczor

Picture two global companies, each operating a range of

different businesses. Company A allocates capital, talent, and research
dollars consistently every year, making small changes but always
following the same broad investment pattern. Company B continually
evaluates the performance of business units,work
acquires
16

and
and in life divests a
by adopting
McKinsey on Finance Number 52, Autumn 2014

Executives can thrive at

Expanding the CFO lens
94
assets, and adjusts resource allocations based on eachmodel
leadership division’s
that relative
revolves around finding their
market opportunities. Over time, which company will be worth more?
strengths and connecting
with others. 95 Are you getting all you can from your board of directors?
If you guessed company B, you’re right. In fact, our research suggests
that after 15 years, it will be worth an average of 40 percent more than 102 M&A as competitive advantage
8888 78_91.indd 78 9/15/10 5:33 PM
company A. We also found, though, that the vast majority of companies
resemble company A. Therein lies a major disconnect between the
aspirations of many corporate
2 Role of the CFO: Selected readings for finance leaders
Arestrategists to boldly
you getting jettison
all you unattractive
can from
businesses or double downyour
on exciting
board newof
opportunities,
directors? and the
reality of how they invest capital, talent, and other scarce resources.
Veteran director David Beatty finds many boards wanting—and considers how
to improve them.

For the past two years, we’ve been systematically looking at corporate
resource allocation patterns, their relationship to performance, and the
Jonathan Bailey and
Tim Koller
implications for strategy. We found that while inertia reigns at most
Boards of directors have always, in all cultures,
represented the shareholders in publicly traded
companies—validating financial results, protecting
their assets, and counseling the CEO on strategy
would be no activist opportunities. That’s
according to David Beatty, Conway Chair of the
Clarkson Centre for Business Ethics and
Board Effectiveness at the University of Toronto’s
What does it mean to be CFO?

04 Which profile best suits your company

10 Rethinking people development in finance

14 Profiling the modern CFO: A panel discussion

20 The Strategist CFO: A conversation with ADP’s Jan Siegmund

25 Building a better partnership between finance and strategy

3 Role of the CFO: Selected readings for finance leaders

22
Today’s CFO: Which profile
best suits your company?
Profiles of today’s CFO show how the role is evolving and raise important questions
for boards about talent and leadership development.
Ankur Agrawal, Most readers are well aware that the role of the
John Goldie, and CFO generally has broadened over the past decade.
Bill Huyett Beyond the core responsibilities of financial
reporting, audit and compliance, planning, treasury,
and capital structure, many CFOs are playing
a stronger role in corporate portfolio management
and capital allocation. Others have become
prominent as the voice of the company in investor
relations and in communications to the board,
as leaders in performance management, and as
exporters of finance-experienced personnel
to the rest of the organization.
Where does it end? It’s unproductive to stretch the
role too far and unreasonable to expect a CFO to be
good at everything. How can the CEO and the
4 Role of the CFO: Selected readings for finance leaders
board—through the audit committee—shape a
manageable profile for the position? It’s an
important question, both for companies hiring a
new CFO and for existing CFOs who see their roles
expanding without a broad perspective.
To get a more detailed picture of how the role
continues to evolve, we analyzed the experience,
credentials, and backgrounds of CFOs of the
top 100 global companies by market capitalization.1
Our review, while not definitive, suggests that
companies are shaping the role to meet their cur-
rent needs. Indeed, we identified four distinct
profiles of the role defined by the breadth of the
current CFO’s experience in finance or in
nonfinance functions; his or her professional focus,

whether it’s an internal focus on operations or
an external focus on strategy; and the sources of
the CFO’s expertise, whether from years of
experience at the current company or another one,
for example, or whether it includes a traditional
accounting degree or some other.
The four profiles include what we would
characterize as the finance expert (or numbers
guru), the generalist, the performance leader,
and the growth champion. And while there is no
single CFO profile that will fit the needs of
every company—each must target candidates with
competencies that best fit their strategy, the
composition of the rest of the company’s top team,
and current finance-function capabilities—
these profiles do offer a glimpse into how the role
is evolving and where peers are looking for
talented and innovative CFOs. They also raise
important questions for board audit committees
thinking about CFO development or the
profile of the person they’d like to hire, as well
as for executives seeking to shape their current
role or considering new ones.
Four profiles of today’s CFO
Management roles vary by organization, depending
on a company’s history, the characteristics of
its industry, and the demands of investors. And
although fitting CFOs into a clear-cut typology
may seem artificial, we found it useful to
understand how companies are filling the role
to get a clearer picture of how it’s changing.
Based on our research, we categorize CFOs into
four general profiles.
The finance expert. Typically internal hires, these
CFOs have years of experience rotating through
multiple roles within the finance function—
controlling, treasury, audit, financial planning and
analysis, or business unit finance. They tend
5 Role of the CFO: Selected readings for finance leaders
23
to have intricate working knowledge of the
company and are often experts in relevant finance
and accounting issues, such as financial regula-
tion, international accounting, or capital structure.
Many have advanced accounting degrees or
experience at an auditing firm.
This type of CFO is particularly well suited to
highly decentralized companies with stand-
alone businesses or early-stage ones scaling up and
professionalizing the finance function. Their
strong finance-function knowledge across a broad
spectrum of activities is critical to effective
compliance and standardization of processes. The
finance-expert profile may also be best for any
company whose top team otherwise lacks strong
finance leadership—or whose finance depart-
ment is inefficient or in disarray.
The generalist. Companies in highly capital-
intensive industries, such as basic materials, oil
and gas, and telecommunications, put a high
premium on operational capabilities. So they
naturally look for executives with broad
experience—including CFOs who have spent time
outside the finance organization—in opera-
tions, strategy, marketing, or general management.
Indeed, among the 51 CFOs in our sample
who were hired since 2009, 31 of them have such
experience, up from 17 of those hired prior to
2009. Among all the CFOs in our sample, 62 have
MBAs or other advanced degrees, compared
with only 28 with advanced accounting degrees—
reflecting a premium for management
and communication skills over deep tech-
nical expertise.
CFOs that fit this description tend to engage
heavily in business operations and strategy and
often bring strong industry and competitive
insights. They’re often found in companies in
24 McKinsey on Finance Number 45, Winter 2013
mature sectors, such as financial institutions,
where operational similarities across business units
provide a good platform to rotate managers
among businesses and eventually into functional
leadership roles; most are internally hired
and already fill an executive function, often being
groomed for a CEO role. These rotations give
managers insights about different businesses that
they need to support tightly run operations,
allocate resources, and influence peers—which,
regardless of industry or strategy, make them
ideal for companies where personal influence is
needed to get things done.
The performance leader. CFOs with strong track
records in transformations both within the finance
function and throughout the organization are
what we’ve dubbed performance leaders. They tend
to focus on cost management, promote the use
of metrics and scorecards, and work to standardize
data and systems. They are often hired externally,
and many have previous experience as CFOs. Most
have worked internationally—explaining in part
why, among the 51 CFOs in our sample hired in the
past three years, 30 have significant experience
in multiple geographies, up from 21 of those with
longer tenures.
Companies employing these types of CFOs are
often highly diversified companies requiring
rigorous analytics to compare performance across
In addition to industry context, companies must
consider how certain CFO characteristics might best
support their own strategic plans.
6 Role of the CFO: Selected readings for finance leaders
businesses, companies with aggressive growth
or cost targets that must be met in the near
term, or companies with scarce resources that
must be carefully allocated.
The growth champion. Externally hired pro-
fessionals are the least common type of CFOs, but
they have risen to account for nearly 25 percent
of new CFO hires. They are most common in indus-
tries with frequent disruptions that require
dramatic changes in resource allocation—and in
companies that plan to grow considerably
or reshape their portfolio of businesses through
aggressive M&A or divestiture programs.
Such moves make external hires especially valued
for their significant experience in M&A, as
well as for their external networks, independent
thinking, and strategic insight, often gleaned
through working as a CFO or serving for years in
professional-services firms. Many growth
champions are among the nearly a third of new
CFOs who have spent a sizable portion of
their career in investment banking, consulting, or
private equity, up from a fifth with a similar
background prior to 2009.
Aligning the role with the company
These profiles are obviously not prescriptive;
it would be simplistic to suggest definitive rules
prescribing a specific CFO profile for general
categories of company. That said, with the profile
Today’s CFO: Which profile best suits your company?
characteristics in hand, companies can more
explicitly weigh them against the skills and
capabilities they expect to require from the CFO
as they shape, refine, and implement their
strategy for the future. Whether this means
selecting a new CFO or rebalancing the role of an
existing one, they’ll need a candid assessment
of their current corporate strategy, the skills and
temperament of the CEO, the composition of
the senior-management team, the current capa-
bilities of the finance function, and organizational
and reporting structures. We propose four
questions (by order of importance) that CFOs
should answer when planning their own
career-development plans—or that CEOs and
boards should answer when beginning the
search for a new CFO.
1. What are your corporate strategy and
aspirations—especially considering the nature
of your industry?
While there are certain trends in the hiring of new
CFOs generally, CFO profiles often reflect the
structure, conduct, and performance of a compa-
ny’s industry. Stable sectors with large global
footprints and extensive supply chains—such as oil
and gas and consumer packaged goods—are
more insular in their CFO selections. Only 4 of 28
CFOs in our sample in these industries were
hired externally, and only 2 had significant experi-
ence outside the sector. However, international
experience is very important, with 9 of 13 CFOs in
oil and gas and 10 of 15 in consumer packaged
goods having worked in multiple geographies. At
the other end of the spectrum are industries
with rapidly changing technology and significant
R&D, such as pharmaceuticals and medical
products (PMP) and technology. Companies in
these industries tend to have CFOs with more
experience in strategy and transactions, and they
7 Role of the CFO: Selected readings for finance leaders
25
are much more likely to select CFOs from
outside the company or the sector. For example,
of the 14 PMP CFOs, 8 were hired externally,
6 had consulting or investment-banking back-
grounds, and 9 had general-management
backgrounds. Over half of CFOs in both the PMP
and technology industries have experience
outside their sector.
In addition to industry context, companies
must consider how certain CFO characteristics
might best support their own strategic
plans. Leadership teams of companies following
inorganic (M&A) growth strategies require
a higher degree of market insight and strategic
orientation. Senior executives of companies
following organic growth strategies, meanwhile,
exhibit a high competency in people and
organizational leadership. So regardless of
industry characteristics—and as long as
candidates meet the threshold of finance expertise
and performance-management skills—a com-
pany embarking on an ambitious M&A program,
for example, would want to give a strong
preference to those with significant transaction
experience and industry insight, more akin to
a growth champion. A company lagging in profit-
ability or undergoing significant industry
consolidation may require a CFO more similar to
the performance leader—strong in performance
management and cost containment.
2. What is the composition of your top-
management team?
The selection of a CFO cannot be made in isolation;
companies must consider the strengths of the
rest of the top team, paying specific attention to its
blind spots and missing capabilities. Recent
research has found that the top teams of high-
performing companies score higher on all
26 McKinsey on Finance Number 45, Winter 2013
measures of leadership competencies—including
thought leadership, people and organizational
leadership, and business leadership—than those of
low-performing companies.2 Finding the right
set of leaders is clearly an important determinant
of corporate performance.3 This means that
the specific profile of your CFO may need to be
different from that for other companies—
even those in the same industry or those that
have similar strategic goals—in order to
create a robust top team.
Companies with a disproportionate share of
leaders with a few areas of deep expertise—
so-called spiky leaders—tend to outperform those
whose leaders have a broad range of more
general skills. This requires members of the top-
management team to build on one another’s
strengths and compensate for one another’s short-
falls. A company with a visionary CEO may
require a CFO with a firm grasp of the economics
of the business and enough influence capital
inside the organization to provide a counterbalance
against potentially risky moves. Or a company
that recently hired a CEO from outside the organi-
zation may require a CFO with deep company
expertise and a firm grasp of the numbers, such
as a person who fits the finance-expert or
generalist profile.
The downside of mistakes in selecting the
top team, and the CFO in particular, is significant.
Myopic top teams can undertake risky or
costly acquisitions, fall behind on innovations in
the market, or fail to retain key talent. High-
performing CFOs must have the integrity and
conviction to challenge the CEO and other
members of the top team on key strategic and
financial decisions and hence steer the
company to a higher performance trajectory.
8 Role of the CFO: Selected readings for finance leaders
3. What is the current level of capability in your
finance function?
As long as a CFO’s profile fits with a company’s
strategy and complements the top team, further
considerations are more tactical. The current
level of capability of the finance function is the
most important of these, since the CFO’s
primary responsibility is to ensure the execution of
core functions of the finance group, especially
strong compliance and controls, accurate data, and
systems integration. If a company struggles with
efficiently performing the basic finance functions
(relative to peers), then it may be necessary
to promote candidates for CFO with considerable
experience in a variety of finance roles and a
track record of performance improvement.
However, if strong capabilities are already present
in the finance organization, a company may
consider candidates with other competencies, such
as broader management experience or strategic
insight. Companies that do so typically pair such
a CFO with a senior finance executive who
manages accounting and other traditional
finance roles.
4. What is the organizational and reporting
structure of your company? Which areas report
to the CFO?
It is also important to consider the company’s
reporting structure—that is, does it have
solid or dotted-line reporting to the CFO—and the
breadth of formal CFO responsibilities.
For example, a CFO in a global company with a
complex matrix structure and only dotted-
line reporting must be able to exert a considerable
amount of personal influence to be successful.
In this situation, it may help to hire a CFO
Today’s CFO: Which profile best suits your company? 27

1 From the top 146 largest companies by market capitalization, we

internally—regardless of which general profile he
excluded Asian companies and 14 others with insufficient
or she fits—who has the networks and institutional public data, for a total sample size of 100 companies. We then
knowledge necessary to drive change. It is also compared CFOs hired prior to 2009 with those hired after.
Note that the pre-2009 sample includes only CFOs who are still
important to define the areas of responsibility that in that role.
2 See Return on Leadership—Competencies that Generate
may lie beyond traditional finance areas, such
Growth, Egon Zehnder International and McKinsey & Company,
as IT, procurement, and transformation, which February 2011.
3 See Katharina Herrmann, Asmus Komm, and Sven Smit, “Do
demand day-to-day hands-on management
you have the right leaders for your growth strategies?,”
and people skills typically seen in the generalist mckinseyquarterly.com, July 2011.
CFO profile.

The right fit between a company and its CFO

involves a complex set of trade-offs reflecting its
strategy, the skills and abilities of top man-
agement and the finance function, and a given
individual’s ability to drive change. Under-
standing how the role is evolving can prompt useful
conversations that shape the CFO’s role at your
company in the future.

Ankur Agrawal (Ankur_Agrawal@McKinsey.com) is an associate principal in McKinsey’s New York office, where
John Goldie (John_Goldie@McKinsey.com) is a consultant; Bill Huyett (Bill_Huyett@McKinsey.com) is a partner
in the Boston office. Copyright © 2013 McKinsey & Company. All rights reserved.

9 Role of the CFO: Selected readings for finance leaders

28
Rethinking people development
in finance
It’s time to overhaul the way companies develop the careers of
finance professionals.
Ankur Agrawal For all the innovation in financial management over
and Bill Huyett the past 20 years, it’s remarkable how little the
process of hiring and developing finance talent has
evolved. Many CFOs do so pretty much as they
did a decade or two ago, recruiting talent from a
largely homogenous pool of candidates, predomi-
nantly with accounting backgrounds or quantitative
skill sets, and assigning most of them to bud-
geting and planning or to finance operations. Many
believe that rotational assignments can create
the breadth that finance function generalists—and
future CFOs—need.
Yet that approach isn’t likely to deliver the leadership
profiles needed to manage increasingly complex
finance organizations and to serve business leaders
broadly in the modern era. Turnover is high. Few
10 Role of the CFO: Selected readings for finance leaders
new hires with an accounting background ever get
the kind of sustained business experience that
would hone their strategic and top-management
advisory skills. CFOs report a growing tension
between demand for traditional finance operations
and demand for finance support elsewhere—in
planning and strategic analysis, reporting to share-
holders and regulators, and coordinating activi-
ties across a complex web of outsourced and auto-
mated transaction providers.
One way to develop the skills that the modern
finance function requires is to differentiate develop-
ment paths for distinct roles: specialists to handle
traditional finance domains; advisers to counsel
senior executives in business units and functions;
and experts to manage areas such as investor

relations, risk management, treasury, or tax-
ation. The recruiting pools and profiles for these
segments would differ, as would their career-
development paths (through rotations or formal
training), and the people in them would be
evaluated and compensated differently.
Operational and financial-services
specialists
The individuals who bear responsibility for tradi-
tional transactional tasks—managing financial
processes (such as journal ledgers, accounts payable,
and receivables) and basic reporting—hold roughly
half of the management roles in most finance
functions. Many of these activities are now handled
by shared-services groups that can standardize
processes and take advantage of scale benefits.
Staff members in these roles often provide
finance transaction support for internal and external
customers. Their development goal should there-
fore be to get broad customer service expertise and
skills, including the ability to ensure zero error
rates, continuous cost and quality improvements,
and legal compliance, as well as the project-
management savvy to run teams dispersed across
a number of locations. Finally, these specialists
should be adept at information technology, given
the increasing use of enterprise-resource-planning
(ERP) systems, and at building relationships with
the third-party vendors that often support finance
subprocesses.
Companies that aggregate these roles into a distinct
professional track could not only recruit individ-
uals for them beyond the typical pool of candidates
with accounting degrees but also better define
their career progression. For many people, a clear
career path would make this track an attractive
one by providing the kinds of skills—motivating
teams, driving quality assurance, improving
processes—that would prepare people for future
11 Role of the CFO: Selected readings for finance leaders
29
roles running groups or projects that share similar
management goals.
A few companies have already adopted an approach
along these lines. One leading transportation
and logistics business, for example, has given the
finance function a lean shared-services center
that hires people with process rather than func-
tional capabilities. Managers measure success
by their ability to develop the organization’s service
quality and process skills rather than functional
knowledge alone, and it now boasts one of the indus-
try’s lowest costs per transaction, high employee
morale, and minimal turnover.
Internal financial-performance advisers
Much of the increasing demand on the finance
function comes from business unit managers
who want support for decisions that affect value
creation and its recognition by equity markets.
At the most senior level, CFOs spend most of their
time in this role, but traditional hires as divi-
sion finance directors are not always well prepared
for it. The best candidates may hold advanced
business and professional degrees, such as MBAs,
or have experience in other parts of the busi-
ness, for these people are more likely to have the
technical, strategic, and competitive knowledge
to integrate finance and strategic thinking. Depend-
ing on the industry, we estimate that the profes-
sionals in this track should account for around
25 percent of the management positions in the
finance function.
Ideally, these advisers would develop the analyses
and reports that executives rely on to make
sound, value-creating decisions—for example, by
explicitly illustrating the trade-offs among
strategic options, such as the balance between
internal and outsourced R&D. They would
also participate more actively in individual M&A
transactions (including quantifying and
30 McKinsey on Finance Number 42, Winter 2012
addressing revenue and cost synergies) and play a
role in improving the competitive distinctive-
ness of the company’s M&A capabilities: the quality
of the pipeline, the speed of decision making,
and the creation of repeatable merger-management
capabilities. (They would, for instance, under-
stand the kind of innovative business and portfolio
modeling that adjusts for a shifting landscape
of competitors, macroeconomic environments, and
customers.) Finally, the advisers would build
leadership capabilities to coach line executives, chal-
lenge inertia and wishful thinking in the allo-
cation of resources to existing businesses, speed
up and improve decision making, and educate
line leaders (for example, about how capital mar-
kets behave).
A number of companies already have such profes-
sional tracks. One large industrial conglomerate,
for example, formally identifies and recruits people
in different parts of the organization for finance
leadership roles. It has a very aggressive, defined
approach to rotations through different busi-
nesses, other functions (such as marketing), and
line leaders who have different management
styles. This breadth of exposure and on-the-job
apprenticeship is coupled with an objective,
stringent performance evaluation process ensuring
that only people who combine technical exper-
tise with top-management peer skills are retained.
Other companies take a less formal approach, iden-
tifying talent by word-of-mouth networks within
the finance function. We also see companies using
major capital projects, new-product introduc-
tions, or acquisitions as opportunities to build the
generalist skills of finance leaders. Both approaches
can succeed, though the formal one is rare and
typically lacks institutional support, while the infor-
mal one works only if the CFO actively partici-
12 Role of the CFO: Selected readings for finance leaders
pates in recruiting, providing opportunities, and
evaluating and mentoring.
Finance function specialists
Some professionals focus on specific, highly
specialized work, such as investor relations, treasury,
audit, risk management, or taxation. Although
most of a controller’s direct reports are likely to be
operational and financial-services specialists,
the controllership itself should be considered a
specialist finance function position.
If the finance function were separated into dis-
tinct career tracks, specialist roles would change
relatively little. Many companies already define
them clearly, and the experts performing them
understand the expectations and likely career
paths. Yet even companies that clearly define the
roles often lack an element of formality in hiring
and in career progression, which is often ad hoc and
opportunistic. Such companies provide little
encouragement or support for developing the exter-
nal networks and reputations of finance function
specialists—critical to help them stay current with
legal and regulatory developments. Clearer for-
mal definitions would allow managers to provide
more structured reviews and more targeted
training and professional-development opportu-
nities for functional specialists, to hire and promote
them more systematically, and to give them a
more exciting and compelling career experience.
One global pharmaceutical company, for example,
encourages its finance function specialists to
develop relationships with academics and other pro-
fessionals outside the company by attending
symposia and conferences, as well as joining pro-
fessional groups. The company also explicitly
rewards people who develop an external reputation
in the profession (for instance, through teaching
Rethinking people development in finance 31

assignments, membership in professional bodies, confront the new demands on it by creating next-
and mentoring affiliations). The result is a more generation recruiting and development programs.
motivated and excited professional staff—with the Separating the roles of people within it to match
added benefit of bringing home outside ideas and the range of activities they perform is a logical
evolving best practices. That’s also an advantage in starting point for change.
recruiting, since the career tracks for many of
these professionals should be part of a progression
in a career started elsewhere, in similar roles
at other companies or in major accounting firms.

The traditional model of hiring, developing, and

promoting talent can no longer deal with the
expanding breadth of demands on the finance
function. It’s time for HR leaders in finance to

Ankur Agrawal (Ankur_Agrawal@McKinsey.com) is an associate principal in McKinsey’s New York office, and
Bill Huyett (Bill_Huyett@McKinsey.com) is a partner in the Boston office. Copyright © 2012 McKinsey & Company.
All rights reserved.

13 Role of the CFO: Selected readings for finance leaders

O C TO B E R 2 015
C o r p o r a t e F i n a n C e p r a C t i C e
Profiling the modern CFO:
A panel discussion
Seasoned finance chiefs explore revamping business models and coping with new competitors, currency
risks, and changing capital structures.
At McKinsey’s annual Chief Financial Officer
Forum, in London this June, CFO and chief oper-
ating officer Samih Elhage of Nokia Networks,
Manik (“Nik”) Jhangiani of Coca-Cola Enterprises,
and former Alstom CFO Nicolas Tissot took up
some of the challenges facing today’s finance chiefs.
Over the course of an hour, the panelists explored
the pricing threat posed by a new breed of low-cost
competitors now rising in emerging markets,
the risks from the resurgent volatility of currency
markets, and the brave new world of cheap debt
financing and its implications for capital structures.
The discussion, moderated by Financial Times Lex
column editor Robert Armstrong, shapes a profile
of the skills and tactics that define the modern CFO.
The edited highlights below begin with the ques-
14 Role of the CFO: Selected readings for finance leaders
© Philip and Karen Smith/Getty Images
tion of whether CFOs should make challenging the
existing business model part of their role.
Nik Jhangiani: A business never gets to the point
where it has the ideal model. The world is changing
so fast around us. Even in a business that you
think is stable and predictable, the operating model
needs to continue to evolve, just given what
technology is doing. At Coca-Cola Enterprises, we
don’t conclude, at a single point in time, that the
business model needs to change—that’s something
we challenge ourselves on through our long-
range-planning process every year.
For example, we have probably the largest sales
force in Europe of any packaged-goods com-
pany, and I almost have to challenge that. Is it
1
 really bringing us the value today that it did five
years ago? How many people want a salesperson
calling on their stores or outlets helping them
to place an order and to merchandise when so much
more can happen through call centers and
technology? You definitely don’t want to lose the
human touch and the relationships, but you
do want to allow your sales force to be more efficient,
effective, and focused on what the customers
view as an added value.
This is something you, as CFO, need to challenge
almost every day—to ask if your company’s business
model is fit for purpose today and, more impor-
tant, if it is fit for purpose for the future. What do
we need to change, without suddenly having to
make a wholesale change tomorrow? It needs to be
constantly adapted.
Robert Armstrong: When you realize that a major
change has to be made, how do you deal with your
executive board?
Nicolas Tissot: Among the members of executive
committees, CFOs are probably best positioned
to challenge the businesses. They are independent
Manik (“Nik”) Jhangiani
Education
Holds a bachelor’s degree in accounting and
economics from Rutgers University
Career highlights
Coca-Cola Enterprises
(2013–present)
Senior vice president and CFO
(2012–13)
CFO, Europe
2
15
from operations. And they are the only ones,
apart from the CEO, who have a comprehensive
vision of the company. The role of a CFO who
goes beyond being a bean counter is clearly not only
to be a business partner but also to be a business
challenger. This is not the easiest part of the job, but
it is definitely a part of the modern CFO role.
Samih Elhage: In a fast-moving industry like
Nokia’s, technology life cycles are becoming very
much shorter. In our case, the transformational
aspect of the business is becoming a way of life. We
can’t say, definitively, that this is really my process;
this is my business; this is how I sell; this is how I buy.
We can say that we’re in a continuous-improvement
process—and the process itself has to evolve.
This isn’t about squeezing the budget to reduce
costs. It’s about significantly changing the com-
pany’s processes and mode of operation. In
many cases, you have to change the way you sell
certain products and the way you charge
particular customers. And, in some cases, you
have to exit specific areas of the business.
When I first came to Nokia, we were operating in
ten different segments. Since then, we’ve made
Bharti Enterprises
(2009–12)
Group CFO
Coca-Cola HBC
(2000–09)
Group CFO
Fast facts
Married, with 2 children
Lives in Central London
Role of the CFO: Selected readings for finance leaders
 incisive and, I think, courageous changes, divesting
eight of these businesses to focus intensely on
the two that would give us the operating perfor-
mance we were looking for.
Competitive dynamics and pricing
Robert Armstrong: Let’s talk a little about com-
petitive dynamics. Samih, you are in a unique
position there. How do you manage the company
when you are constantly under pressure from
large, low-cost emerging-market competitors?
Samih Elhage: Well, competition is undeniably
an important element in our day-to-day operations,
because of its implications for our cost structure
and for pricing. But we resist being driven reactively
Nicolas Tissot
Education
Holds an MBA from École des hautes
études commerciales (HEC) and graduated
from École nationale d’administration
Career highlights
Alstom
(2015)
Adviser to the group chairman and CEO
(2010 –14)
CFO and executive-committee member
Suez/GDF Suez/ENGIE
(2008–10)
Deputy CEO, global gas and liquefied
natural gas
(2005–08)
CFO and executive-committee
member, Electrabel
16 Role of the CFO: Selected readings for finance leaders
by the actions of competitors. We have a strong
pricing strategy and controls to ensure that prices
are being set at the right level—one that ensures
our customers are getting value for money and that
we are able to fund investment in R&D and
healthy performance for our stakeholders. And, in
a competitive environment, our cost structure,
which is extremely lean, gives us the means to fight
when fighting is what’s required.
Robert Armstrong: Let’s explore that pricing
theme a bit. Nik, how does pricing feed into the
finances of Coca-Cola Enterprises?
Nik Jhangiani: It is a huge element. Fortunately, in
the last couple of years we’ve benefited from
(2003–05)
CFO and executive vice president,
Energy International
(1999–2003)
Head of group financial planning and control
French Ministry of Economy, Finance,
and Industry
(1995–99)
Inspecteur des Finances, the senior audit and
consulting body of the ministry
Fast facts
Married, with 4 children
Member of the French-American Foundation
(and former FAF Young Leader) and the Société
d’Economie Politique
Independent director at Euroclear Settlement
of Euronext-zone Securities
3
 the more benign commodities environment. As
recently as four or five years ago, inflation was high,
and we had to find a way to pass that on to our
customers and our consumers. Today, some markets
in Europe are actually facing deflation, and your
customers and consumers are looking at that, too.
What we’re not able to achieve through pricing,
we have to do by reducing costs—finding better
ways to be efficient at what we do.
The answer isn’t always about the absolute price
the market will bear. Sometimes, it’s much
more about what you can do from an overall revenue-
growth perspective. In addition to cutting costs
and increasing prices, how do you get the right mix
of products to generate more transactions?
How might you change your packaging strategy
to increase revenue growth? For example,
would consumers want—and pay a slight premium
for—a smaller or differentiated or more
premium package?
Samih Elhage
Education
Holds a bachelor’s degree in electrical
engineering and in economics from
the University of Ottawa, as well as a master’s
degree in electrical engineering from École
Polytechnique de Montréal
Career highlights
Nokia Networks
(2013–present)
Executive vice president and CFO
(2013–present)
Chief operating officer, Nokia Solutions
and Networks
4
17
Nicolas Tissot: In heavy industries, the pricing
environment is always driven by the business cycle.
For several years, we’ve been in a crisis that also
has some structural components. So we’ve had to
adapt structurally to the emergence of new
competitors from places with a lower cost base. We
also need to adjust to the interest of our clients
in our services, as well as our technology. The CFO
is instrumental, for example, in launching
performance and restructuring plans, setting up
partnerships, allocating R&D money, and
reorienting manufacturing investment.
On pricing, we need to adapt rapidly or we’ll lose
every sale. At one time, deals targeted a level of
profitability that fully rewarded our investments.
But when there is overcapacity in the market
and when—to break even—competitors fight to
keep factories running, sometimes you end
up settling for the second-best price. At Alstom,
the CFO, who personally approves every
Nortel
(2009–10)
President, carrier voice over Internet Protocol
(VoIP) and applications solutions
(2008)
Vice president and general manager, carrier
VoIP and applications solutions
(2007–08)
Vice president, corporate business operations
Fast facts
Married, with 2 children
Pastimes include world music, traveling,
walking, and golf
Role of the CFO: Selected readings for finance leaders
bid above €50 million, has to take into account
those specific periods and relax the margin
targets appropriately.
Foreign-currency risk
Robert Armstrong: Currency risk has returned
to the corporate world’s attention over the past
year, with the strong dollar and the fluctuations
of other currencies. How do you manage
the risks?
Samih Elhage: I start with how we should achieve
our performance goals and then ask how we cope
with the challenges of all external aspects, including
currency fluctuations. In our business, we depend
mainly on four currencies—the euro, the US dollar,
the Japanese yen, and the Chinese yuan. We
usually get our performance plan approved by the
board in Q4 and make any changes at the beginning
of the year. From there, I ask teams to develop
their performance plans reflecting the impact of
currencies. Their underlying business objec-
tives have to be achieved from an operating-profit
perspective, and that comes down to cash.
If the effect of currency shifts help the top line,
that’s assumed to be in addition to the team’s
performance goals. If currency shifts affect costs
negatively, the team has to find some way of
compensating for that.
Is that challenging? Absolutely. It adds to the
pressure on teams to meet their goals. Are we mak-
ing progress? Yes, we are. But costs associated
with hedging have to be included in the accounting
statements, and they have cash implications.
Our teams know that they just have to make the
numbers add up.
Nik Jhangiani: The countries in which Coca-Cola
Enterprises operates give us a fairly natural
hedge—because our revenues and a great deal of
our cost base are local. In fact, we produce
18 Role of the CFO: Selected readings for finance leaders
90-plus percent of our products within a given
market. It’s difficult and expensive to trans-
port water. Producing locally gives us another
natural hedge.
The issue is more with our commodity exposures,
which could be in different currencies. That’s where
we make sure that we’re covering risk through
transactional exposures, for which we hold teams
accountable—having hedging policies in place
and ensuring that all our transaction exposures are
covered, at least on a rolling 12-month basis
(with lower levels of coverage going out 36 months).
Teams are responsible for making sure that
currency risks are covered through pricing and
cost structures and so on.
Our hedging strategy is very clear. We’re not looking
to beat the market. We are just trying to increase
certainty around our cost structure. We do not hedge
for translational currency conversion or exposure.
When we communicate with the market, we actually
give guidance and provide our performance data
both on a currency-neutral basis and then with the
impact of currencies. The transaction part is built
into the information we provide.
You can’t keep changing what you do in volatile times,
as that volatility will always be out there. At
times, translation or currency conversion works
and has some benefits, and at times it doesn’t.
You have to try to ride through that cycle without
being reactive and changing things, unless you see
something that isn’t working over the long term.
Nicolas Tissot: We see our business as being a
supplier of industrial equipment and associated ser-
vices, not playing games with the fluctuations
of currencies. As soon as an order is firmed up, we
have a full analysis of the currency flows. Then
that exposure is systematically hedged over the hori-
zon available in the market, with a rolling forex
strategy. We have pretty significant activity in that
5
 respect. To avoid paying too much in fees to the
banks, we use an electronic platform. The banks
own the platform and it is competitive for any
forex trade that we handle to hedge our exposure.
Capital structure
Robert Armstrong: One of the ironic conse-
quences of the financial crisis is that debt
financing is cheap and easy to get unless you’re
a bank. It’s so cheap, why have any equity at
all? How do you make capital-structure decisions
in this context?
Nicolas Tissot: Regarding debt financing, over the
past few years there have been times when we’ve
needed to think fast, act fast, and be opportunistic.
There are imperfections in the market, and many
of us have seized the opportunities they create. But
at the same time, you always have to keep the
long-term view in mind.
Alstom is in a very cyclical industry, and sometimes
you can lose sight of your position in the cycle.
When things are good, there’s a risk of leveraging
too much; when the hard times come back, you
burn a lot of cash and quickly deteriorate your finan-
cial structure and therefore your rating, which
leaves you little if no access to debt markets.
We manage our financial structure—the structure
of the balance sheet—with that in mind. At the
peak of the cycle, we want to have almost no leverage,
while at the trough we accept more.
Samih Elhage: At Nokia, our capital-structure
decisions are guided by the principle that we should
always do our best to give back to shareholders. In
the past two years, as we purchased Siemens’s share
of Nokia Siemens Networks and sold the device
business to Microsoft, we put in place a program to
improve our capital structure and to return
€5 billion to shareholders over three years.
6
19
Why have equity at all? Our philosophy is that
there should be a balance. You should go to the mar-
ket when you must, but you also need a very strong
capital structure to defend the business and to drive
the right investment at the right time.
Nik Jhangiani: We sold the US business back to
the Coca-Cola Company in 2010 and formed the
new Coca-Cola Enterprises. That included much of
the debt we had, as well. We continue to generate
a great deal of free cash flow, but at the same time
we also realized that we were very underleveraged
and didn’t have the most efficient balance sheet.
So we set a leverage target of two and a half to three
times net debt to EBITDA, compared with where
we were before the sale, which was closer to one to
one and a half times net debt to EBITDA. It could
have been lower, but we picked a level that we saw
as the right starting point for the journey we
wanted to make. We would slowly lever up toward
that level, so this wasn’t a big one-shot bang,
and we wanted to make sure we had enough dry
powder for potential activities.
The leveraging up, along with the free cash flow
that we continue to generate, and a strong focus on
that cash-conversion rate gives us a solid pool
of free cash flow. In the absence of M&A, the best
way to use it was to return it to shareholders.
Over the last four years, from the formation of
the new Coca-Cola Enterprises through the
end of 2014, we have returned approximately
$8 billion to shareholders.
Copyright © 2015 McKinsey & Company.
All rights reserved.
Role of the CFO: Selected readings for finance leaders

The strategist CFO: A conversation
with ADP’s Jan Siegmund
As the finance chief’s remit has grown, companies have looked further afield to fill the role. Here’s how
a former chief strategy officer fits in.
Basel Kayyali and Ishaan Seth
Broader expectations of the role of the finance
chief are leading to some unconventional CFOs—
executives with deep experience outside the
traditional finance, comptroller, and accounting
career paths. This is especially so the more
companies rely on the CFO to shape, refine, and
implement their strategic plans. The best can-
didate for the role, as some of our colleagues have
noted, reflects a balance among the demands
of a company’s strategy, the skills and abilities of
the CEO and other senior managers, and the given
individual’s ability to drive change.1
So perhaps the logic was obvious three years ago,
when ADP tapped its chief of strategy, Jan Siegmund,
to step into the CFO role. A 15-year veteran of the
14 McKinsey on Finance Number 54, Spring 2015 20
© Sergey Nivens/Getty Images
data-processing company, which boasts $12 billion
in annual revenues, Siegmund describes his
chief-strategy-officer (CSO) tenure as marked by a
series of changes that transformed ADP from
a primarily national payroll-centric company to
a global human-capital-management company.
That experience has proved helpful for Siegmund as
CFO, especially in his ongoing efforts to transform
ADP’s finance function.
We recently sat down with Siegmund in ADP’s
Roseland, New Jersey, headquarters to discuss his
role as CFO, ADP’s finance transformation,
and the impact of technological innovation on the
industry. (An abridged video of the conversation
is available on mckinsey.com.)
Role of the CFO: Selected readings for finance leaders
McKinsey on Finance: How did the transition
from CSO to CFO come about?
Jan Siegmund: I joined ADP around 15 years ago
and spent more than a decade in a variety of
strategy roles. It was about two-and-a-half years
ago that our CEO, Carlos Rodriguez, approached
me about taking on the role of CFO. It caught me by
surprise, I have to admit, because it had not been
core and center to my own career planning.
Throughout the discussions with him and the board,
it became clear that ADP was seeking to interject
more of a strategic view into the finance organization.
ADP, as a company, has had a very strong foun-
dation in finance, but the function was a little more
operations and transaction oriented than it should
be. Part of the idea and intent of transitioning
me into the role of CFO was to add a component of
driving change a bit more aggressively—not only
for the finance organization itself but also for leverag- particular the areas that had not been natural areas
ing the role of the CFO to help the company
accelerate its performance over time.
That was consistent with my career as a CSO,
which focused on executing change programs for
the company—whether facilitating and driving
acquisitions or divestitures, instituting new product
introductions, or building different skill sets
across the organization. I think that experience
helped me become the kind of action-oriented
person needed in a large, classic function
like finance.
McKinsey on Finance: How did serving
as chief strategy officer prepare you to be an
effective CFO?
Jan Siegmund: As a chief strategy officer, one
has a unique opportunity to think about the
enterprise in its completeness—to focus on the big-
growth drivers and performance drivers for a
company. That kind of prioritization is also crucial
The strategist CFO: A conversation with ADP’s Jan Siegmund
21 Role of the CFO: Selected readings for finance leaders
to being effective in the CFO role, where it’s easy to
lose the big picture of what’s needed to drive the
company’s success in myriad daily transactions. For
me, that was one of the biggest benefits of having
a background in strategy: the ability to take apart
complex problems, isolate core performance
factors, and focus on those—and to set aside smaller
issues that can eat into your day.
McKinsey on Finance: What is it like coming
into the CFO role without the technical
background in areas such as accounting and
treasury management?
Jan Siegmund: As an unconventional CFO, you
have to have a fair amount of respect for the
function. There’s a huge amount of learning to be
done in the initial years to perform well. During
my first 100 days, I invested a significant amount
of time in learning and understanding—in
of focus for me, namely external reporting,
compliance, audit, tax, and treasury functions.
Like most strategists, I like to think of myself as a
lifelong learner—I like to understand and to dig deep
into problems. Bringing that mind-set into the
finance role helped me learn about the needs of our
external-reporting functions, the compliance
needs, tax needs, audit needs, and so on. Being open-
minded and being an avid learner clearly helps a
CFO with a nontraditional background. I also had a
strong team that was very patient with me—that
also helped. Is it a good idea for other companies to
follow, in some ways, in ADP’s shoes—to have
CFOs without that kind of technical training? It would
be hard to generalize. Every company is different.
In ADP’s case, we had a successful, highly function-
ing finance function that needed strategic direction—
and it seemed I was a good fit for the role. But
without that kind of context, a board would probably
want to consider different profiles for the role, to
meet the specific needs of its company.
15
 McKinsey on Finance: Going back to your unique
background, do you think one person can fulfill
both the strategy and comptrolling requirements
of a large, multinational company? Is there a
future where the two roles converge?
Jan Siegmund: At ADP, the chief of strategy drives
our corporate strategy, and the role is separate
from the chief of finance. I’m a big proponent of that
split and it serves us well. As a CSO, you need
to have the time and resources to think about what
affects a company’s long-term trajectory
without the demands of a broad set of daily
operational responsibilities.
compliance, external reporting, tax, and so forth.
If anything, those things are getting more and more
complex. What I do see is that many chief exec-
utives are searching for a CFO who can be a more
strategically oriented business partner—who
can help the senior management team make better
use of the finance function’s resources. The CFO
today needs a balanced set of skills that combines
a focus on long-term success with the ability to
be a change agent for the organization.
McKinsey on Finance: Let’s talk about the
finance transformation that you are leading at
ADP. How did that come about?

That’s different from being a strategically focused
and strategy-minded CFO; and the scope of the
role has always oscillated as companies defined it in
various forms. I don’t see a general trend toward
changing the core elements of being a CFO—
Jan Siegmund: ADP’s finance organization
has long been a strong, capable, and important part
of its broader culture and its success. But over
the past 30 years, it had grown rather complex, and
we hadn’t undertaken a fundamental review of

Jan Siegmund
Education (2000–04)
Holds a PhD in economics from Senior vice president, strategic
Dresden University of Technology, an development of brokerage services
MA in economics from University of
(1999–2000)
California, Santa Barbara, and an MS in
Vice president, strategy
industrial engineering from Karlsruhe
Institute of Technology
McKinsey & Company
(1993–99)
Career highlights
Consultant
ADP
(2012–present)
Fast facts
CFO
Is a board member of the Lesbian, Gay,
(2007–12) Bisexual & Transgender Community
President, value-added services Center in New York City, where he lives
with his husband, Ben; is a passionate
(2004–12)
cook and gardener
Chief strategy officer

16 McKinsey on Finance Number 54, Spring 2015 22 Role of the CFO: Selected readings for finance leaders
“I don’t see a general trend toward changing the core elements
of being a CFO. If anything, those things are getting more
and more complex. What I do see is that many chief
executives are searching for a CFO who can be a more
strategically oriented business partner.”
its effectiveness. After my first 100 days of listening
and learning, the senior team and I got together,
and we decided that we had significant oppor-
tunities to change how finance would contribute
to ADP. We launched, basically, a finance-
transformation process that covered outsourcing
our external-reporting function, optimizing our
order-to-cash processes, as well as a real rethinking
of our global financial-planning-and-analysis
(FP&A) organization.
The biggest success I’m seeing is that reorganizing
and rethinking how we want to deliver decision
support and FP&A functionality will yield a lasting
contribution for ADP. We started by establishing
centers of excellence: how do we do revenue
forecasting and planning, for example. We’ve built
much better data and analytics capabilities
in our offshoring location and have started rethink-
ing the role of our field support with new
definitions, new career paths for our associates,
and different skill requirements. A side effect
of this is that we will also save a considerable amount
of money. ADP used to spend about 2 percent
of its revenues on its finance function, and we were
overinvested versus the benchmark. Our goal
is to bring that down over the next year or two to
around 1.2 to 1.3 percent of revenue.
McKinsey on Finance: What challenges have you
encountered while trying to transform the finance
function at ADP?
The strategist CFO: A conversation with ADP’s Jan Siegmund
23 Role of the CFO: Selected readings for finance leaders
Jan Siegmund: I have led a number of larger
change programs throughout my business career.
One thing I’ve learned is that change programs
in a finance organization are very complex. The
functions we perform are often interlinked with a
variety of work streams, and unwinding them to
implement change while still maintaining a strong
control environment and full compliance with
the law can be challenging. Moreover, finance
teams typically haven’t experienced a lot of change
processes on their own. I found my finance
team a little hesitant, almost needing to muscle-
build change processes while engaging in the
process. The change readiness of the organization
was a little lower than I expected. It took a lot of
communication, team building, and aligning with
a joined vision of the finance team to get the
process going. But after we overcame the initial
hesitation, we got good momentum. I would
say we have completed phase one, and phase two is
still to come.
McKinsey on Finance: If you reflect back on your
first couple of years as CFO, both in the finance
transformation and how you transitioned into the
role, what would you do differently?
Jan Siegmund: Anyone appointed to a role like
CFO of ADP will spend the first two years drinking
from the proverbial fire hose. Getting into the
job is an enormous task, and making the best use of
time involves complex trade-offs. In my case,
17
 I invested a good amount of time in shareholder and
investor communications, learning about the
accounting and regulatory functions of the role,
and establishing a good working relationship
with our board and audit committee. Because those
external pressures are demanding and take
priority over internal pressures, I wish I could have
invested more time building a more intimate
relationship with the field organization, working
directly with teams to understand their pressures—
in finance in particular.
McKinsey on Finance: What do you think about
the pace of technological change that’s going on in
the industry?
Jan Siegmund: It’s incredibly exciting to be a part
of the HR technology and service market because
big technology trends, like mobility, globalization,
and the movement to the cloud are all intimately
affecting our business. Companies are more global,
and employees expect HR solutions that have the
functionality and ease of use of Facebook—and big
data and cloud delivery are key factors in that.
Big data may be a perfect example. Many people
know the ADP National Employment Reports
and our ability to predict the growth of the national
labor market very well. Now we’re using the vast
amount of HR and payroll data that we have in our
systems to provide our clients specific, analytical
support to better understand how their organi-
zations can leverage their employees to be more
effective and more engaged, to make better
contributions to their business. Namely, we’re
providing a set of benchmarks that companies can
use to analyze the effectiveness of their own HR
organization—to leverage and better understand
wage levels and benefit levels that they should
provide compared with their competitors, or with
participants in similar market segments. The
application of big data at ADP will mean that ser-
vices we already offer today will become even
18 McKinsey on Finance Number 54, Spring 2015 24
more valuable for our clients. We’re excited about
the opportunities that big data, as a trend,
offers to us.
The cloud is also affecting us and our clients—it’s
a welcome technology trend that allows us to deliver
our solutions to clients in an even faster and
more cost-effective way. Today, about 75 percent
of ADP’s clients already process on the most
modern SAS2 solutions in the cloud. The excitement
for us in ADP is about leveraging these global
trends and accelerating and enhancing our
own value proposition.
McKinsey on Finance: Thinking back across your
various roles, how important has storytelling
been in the way you communicated about strategy
and now about financial results?
Jan Siegmund: One of my early observations as
a new CFO meeting with shareholders and analysts
was how helpful it was to have a background
in strategy when telling the company’s story. Most
professional investors have a fairly good insight
into the actual financials, but what they’re missing
is the context, understanding, and drivers of
certain business decisions. So I spend much of my
time in investor meetings telling the story of
ADP rather than reconciling financial results that
are already available in our reports.
1 Ankur Agrawal, John Goldie, and Bill Huyett, “Today’s CFO:
Which profile best suits your company?,” January 2013,
mckinsey.com.
2 Statistical analysis system.
Basel Kayyali (Basel_Kayyali@McKinsey.com) is
a principal in McKinsey’s New Jersey office, and Ishaan
Seth (Ishaan_Seth@McKinsey.com) is a director in
the New York office.
Copyright © 2015 McKinsey & Company.
All rights reserved.
Role of the CFO: Selected readings for finance leaders
O C TO B E R 2 015
Building a better partnership
between finance and strategy
The growing strategic role of CFOs may create tension with top strategists. That’s a missed opportunity for
teaming up to improve company performance.
Ankur Agrawal, Emma Gibbs, and Jean-Hugues Monier
Two-thirds of all executives agree that the best way
for CFOs to ensure their company’s success
would be to spend more time on strategy.1 Indeed, it
is increasingly common for CFOs to be taking
on more strategic decision making. Companies
value the hard data and empirical mind-set
that a finance chief can lend to strategic planning,
especially around forecasting trends, building
strategic capabilities, or managing government and
regulatory relationships.2
Yet as CFOs map out what can be a wide range of
strategic responsibilities, they may encounter
challenges and even turf wars from some traditional
strategy leaders, such as chief strategy officers
(CSOs) and business-unit heads. These seldom
25 Role of the CFO: Selected readings for finance leaders
© Piotr Powietrzynski/Getty Images
boil over into public view, but we often see signs of
tension where the two roles increasingly overlap.
Such friction is destructive—and a missed oppor-
tunity. Working together, CFOs and CSOs have
the stature to challenge biases and influence how
the top team makes decisions to improve a
company’s performance. In many cases, a CSO may
be better placed to take on certain roles typically
managed by the CFO, such as owning the resource-
allocation map or the M&A process. Many CFOs
are the first among equals on a company’s board of
directors and can assist CSOs at improving board
productivity on strategy. Having explicit conversa-
tions about expectations and the division of
such roles will improve the dynamics of strategic
1
 decision making—by ensuring a better link between
a company’s capital allocation and its strategic
priorities, by better informing a search for growth,
and by better balancing a company’s strategy for
long-term growth with its short-term strategy for
earnings and investors.
Better linking capital allocation to
strategic priorities
Research by our colleagues finds that, on average,
companies allocate 90 percent or more of their
resources to the same projects and activities year
after year, regardless of changes in the environment
or their strategies.3 Dynamic companies that
reallocate resources more actively deliver better,
less volatile annual returns to shareholders, on
average, than their more dormant counterparts4—
particularly during economic downturns.5
CSOs and CFOs each bring insights to create a better
link between resource allocation and strategy in
the corporate-strategy-development process. This
means, among other things, creating a distinct
corporate- or portfolio-strategy process (rather than
just aggregating business-unit plans); encouraging
more frequent conversations among small groups of
senior leaders on an ongoing basis, rather than
annually or every three to five years; and ensuring
that the corporate-strategy and budgeting pro-
cesses are fully integrated with capital-allocation
processes (including M&A and divestment). This
integrated view of strategic direction and resulting
allocation of corporate resources demands close
collaboration between finance and strategy.
Working together, CFOs and CSOs have the stature to
challenge biases and influence how the top team makes
decisions to improve a company’s performance.
2
26 Role of the CFO: Selected readings for finance leaders
In the case of one North American healthcare
company, the CSO set up a planning council that
included the CFO to discuss strategic issues,
growth opportunities, and funding needs. For each
of the promising opportunities—which carried
the imprimatur of both the CFO and the CSO—the
council appointed a strategic leader. Each leader
was tasked with creating a deliberate dialogue with
existing business leaders and cultivating their
support for more than a dozen related initiatives
well in advance of the annual allocation process. As
a result, the council was able to aggressively
challenge the expenses attributed to running the
business and set aside a defined amount for
growing the business instead. This result clearly
was achieved due to the foresight and trusted
collaboration of the CFO, the CSO, and their teams.
CSOs can also track how critical resources such as
growth investments and talented R&D teams
are used. This allows managers to assess whether
resources are allocated to support strategy—
or whether each year’s capital allocations unduly
influence the next.
Finally, CSOs can pay close attention to the way
strategic decisions are made, for example, by
managing the executive team’s strategic agenda and
prompting debate on competing options and
scenarios to account for inherent sources of bias.
Often this means bringing external data into
the room to help reanchor discussions away from
assumptions based on prior decisions. The CSO
at a consumer-products company, for example,
used this approach to good effect when managers
found themselves facing a major disruption
in a core market. The CSO shepherded the executive
team through a series of strategic decisions
that allocated resources away from traditional cash
cows. Instead, she shifted attention and resources
into a disruptive technology identified by the
company’s widely accepted strategy review as the
future of the business. To guide the discussion,
she clearly laid out the level of resources needed to
fund the agreed-upon strategy, reminded the
executive team of the rationale for the change of
direction, and carefully positioned each decision
to reduce the likelihood of bias.
Looking outside the company for insights
into growth
CFOs agree that companies need to step up their
game in a wide range of growth-related activi-
ties, particularly driving organic growth, expanding
into new markets, and pursuing M&A. Recent
McKinsey research shows that more than 60 per-
cent of growth comes from riding on favorable
tailwinds—that is, doing business in markets that
are growing well and where com-panies enjoy
a competitive advantage.6 However, a 2010 survey
found that less than 15 percent of executives
consider such macroeconomic trends when they
develop strategy, and only 5 percent take their
competitors’ strategies into account.7 Moreover,
less than a quarter even look at their own
internal financial projections and portfolio perfor-
mance. Little wonder that companies and their
CFOs struggle to find growth; they’re looking at
a mirror and not a window.
CSOs are well placed to help correct this. Many CSOs
own the organization’s trend-forecasting and
competitor-analysis function. Good trend forecast-
ing involves creating proprietary insight into
trends, discontinuities, and potential shocks to find
growth opportunities and manage business risk.
Similarly, good competitor analysis involves
27 Role of the CFO: Selected readings for finance leaders
gathering competitive intelligence, closely tracking
the behavior of competitors, monitoring their
potential responses to a company’s strategic moves,
and evaluating their sources of competitive
advantage. All are necessary to understand how a
company creates value—the foundation of the
strategic decisions that best balance a corporate
portfolio for risk and return. Armed with such
insights, CFOs and CSOs together are better placed
to go beyond a CFO’s traditional strengths in
managing the portfolio, navigating it toward growth
opportunities, setting objectives for organic
growth, and planning a strategy for M&A.
The experience of a CFO and CSO at one industrial
conglomerate is illustrative. The newly appointed
CSO developed a proprietary view of what
contributed to each business’s growth and injected
that insight into corporate-strategy discussions.
Underlying factors included, for example, projec-
tions down to the level of how much new
commercial floor space would be built in Latin
American cities—a central variable in fore-
casting demand for the company’s most advantaged
products, such as electrical wiring. The CFO, in
turn, provided data and analytical rigor in assessing
the business case for each product. In particular,
the CFO created a database that empirically evalu-
ated pricing relative to demand and the number
of competitors in each submarket. With information
at this level of detail, the executive team could
see which businesses in the company’s portfolio
were the best positioned to capture pockets of
growth. Not only were they better able to set targets
for organic growth, which the CFO now uses
to manage performance, but they also used the
information to develop a clear acquisition
and divestment strategy.
Taking a long-term strategic view to
offset short-termism
A key challenge at any company is balancing the long-
term growth strategy against the demands of
3
 increasingly vocal short-term investors. Working
together, a strategist’s deep understanding of
regulation, innovation, and microeconomic
industry trends complements a CFO’s understanding
of cost and revenue, capital allocation, and
stakeholder issues. Together, they can put forth
options that improve both a company’s short-
term earnings and its longer-term growth in a way
that is compelling to management, boards,
and investors.
To facilitate collaboration, one company explicitly
rotates strategy and finance professionals between
the two teams. Formal structures, such as
the strategic-planning team, include people from
both—strategic planning has two from each—so
that they start the budgeting process hand in hand.
That enables both sides to see how resources
align with the long- and short-term strategies as
they make long-term resource allocations,
evaluate make-or-buy decisions, and challenge
the business case.
Working together, finance chiefs and strategy
leaders can complement each other, helping the CEO,
the board, and the rest of the executive team face
the challenges of creating growth over the long term
in the face of so many short-term challenges.
4
28
1 Ankur Agrawal, Kaustubh Joshi, and Ishaan Seth, “The CFO’s
role in the pursuit of growth,” June 2013, mckinsey.com.
2 Michael Birshan, Emma Gibbs, and Kurt Strovink, “What
makes a great chief strategy officer,” Harvard Business Review,
May 14, 2015, hbr.org.
3 Stephen Hall, Dan Lovallo, and Reinier Musters, “How to
put your money where your strategy is,” McKinsey Quarterly,
March 2012, mckinsey.com.
4 Michael Birshan, Marja Engel, and Olivier Sibony, “Avoiding the
quicksand: Ten techniques for more agile corporate resource
allocation,” McKinsey Quarterly, October 2013, mckinsey.com;
and Stephen Hall and Conor Kehoe, “How quickly should
a new CEO shift corporate resources?,” McKinsey Quarterly,
October 2013, mckinsey.com.
5 Mladen Fruk, Stephen Hall, and Devesh Mittal, “Never let
a good crisis go to waste,” McKinsey Quarterly, October 2013,
mckinsey.com.
6 Mehrdad Baghai, Sven Smit, and S. Patrick Viguerie,
“The granularity of growth,” McKinsey Quarterly, May 2007,
mckinsey.com.
7 “Creating more value with corporate strategy: McKinsey
Global Survey results,” January 2011, mckinsey.com.
Ankur Agrawal and Jean-Hugues Monier are
principals in McKinsey’s New York office, and Emma
Gibbs is an associate principal in the London office.
Copyright © 2015 McKinsey & Company.
All rights reserved.
Role of the CFO: Selected readings for finance leaders
Principles of value creation

30 How to choose between growth and ROIC

34 Are you still the best owner of your assets?

29 Role of the CFO: Selected readings for finance leaders

 

How to choose between growth

and ROIC
Investors reward high-performing companies that shift their strategic focus
prudently, even if that means lower returns or slower growth.

Bin Jiang and Value-minded executives know that although growth is good, returns on invested
Timothy Koller capital (ROIC) can be an equally—or still more—important indicator of value creation.1
Yet even executives at the best companies often wrestle with strategic decisions in
order to reach the right balance between growth and returns. We repeatedly come across
executives whose companies earn high returns on capital but who are unwilling
to let those returns decline to encourage faster growth. Conversely, we see executives at
companies with low returns working to promote growth instead of improving their ROIC.

1 Bing Cao, Bin Jiang, and Timothy Koller,
“Balancing ROIC and growth to build
value,” McKinsey on Finance, Number 19,
Spring 2006, pp. 12–6.
2 For more on this topic, see Nicholas F. Lawler,
Robert S. McNish, and Jean-Hugues J.
Monier, “Why the biggest and best struggle
to grow,” McKinsey on Finance, Number 10,
Winter 2004, pp. 17–20.
3 Normalized to 2003 dollars.
4 Those with a ten-year average ROIC greater
than or equal to 20 percent in 1995.
Large companies in particular can
find it difficult to grow without giving
up some of their existing returns.2
What’s more, many executives are
accustomed to seeing growth and returns
improve (or decline) hand in hand as
market conditions change. As a result,
decision makers may hesitate to
alter strategic directions, fearing a lag
in market acceptance.
To understand better how value is
created over time, we identified all non-
financial US companies that had a
market cap over $2 billion3 in 1995 and
had been listed for at least a decade
as of that year. When we examined their
growth and ROIC performance over
the subsequent decade, we found clear
patterns in the interaction between
the two measures. These patterns can help
guide value-creation strategies suited
to a company’s current performance.
For companies that already have high
ROIC s, 4 raising revenues faster than
the market generates higher total returns
to shareholders (TRS) than further
improvements to ROIC do (Exhibit 1).
This finding doesn’t mean that companies

30 Role of the CFO: Selected readings for finance leaders

 Web 2007
Growth
Exhibit 1 of 3
0 Financethat already have high returns onAutumn
McKinsey
Glance: Foron
companies invested2007
capital (ROIC), growth
generates higher returns to shareholders (TRS) than further improvements to ROIC.
Exhibit title: High ROIC

Exhibit 1
High ROIC Total returns to shareholders (TRS)1 for companies with high returns on invested capital (ROIC),2
1996–2005, %
For companies that already have high Median TRS exceeds market
ROIC, growth generates higher TRS than
further improvements to ROIC.
Difference,
S&P 500 average = 6.9 percentage points

15

Increased 7 8

ROIC3

11
Decreased 6 5

Below Above

Growth, CAGR of revenues

Difference, 1 4
percentage points

1Median of compound average annual TRS from 1996 to 2005 for each group of companies, adjusted for compound
1996–2005 average TRS of S&P 500 index companies (6.9%).
278 companies with 10-year average ROIC ≥20% and market capitalization >$2 billion in 1995.
3Excluding goodwill.

5 Those with a ten-year average ROIC in 1995
greater than or equal to 9 percent but less than
20 percent.
6 Because our data represent the median of a
group, a company could achieve above-
market TRS even though its growth was below
market or its ROIC had declined.
with high ROIC s can disregard the impact
of growth on their profitability and
capital returns. But executives do have the
latitude to invest in growth even if ROIC
and profitability erode as a result—as long
as they can keep ROIC levels in or above
the medium band.
Companies that fall in the middle of
the ROIC scale5 (Exhibit 2) have no latitude
to let their performance on either measure
decline. For these companies, improving
ROIC without maintaining growth at the
pace of the market or generating growth
at the cost of a lower ROIC usually results
in a below-market TRS . In most cases,
the market rewarded these companies with
above-market returns only when they
maintained their growth and improved
their ROIC .6

31 Role of the CFO: Selected readings for finance leaders

 Web 2007
Growth
Exhibit 2 of 3
How to choose between 
Glance: Companies withgrowth
mediumand ROIC
ROIC must maintain their growth and improve their ROIC.
Exhibit title: Medium ROIC

Exhibit 2
Medium ROIC Total returns to shareholders (TRS)1 for companies with high returns on invested capital (ROIC),2
1996–2005, %
Companies with medium ROIC must maintain Median TRS exceeds market
their growth and improve their ROIC.

Difference,
S&P 500 average = 6.9 percentage points

10 4
Increased 6

ROIC3

5
Decreased 7

Below Above

Growth, CAGR of revenues

Difference, 4 3
percentage points

1Median of compound average annual TRS from 1996 to 2005 for each group of companies, adjusted for compound
1996–2005 average TRS of S&P 500 index companies (6.9%).
2129 companies with 10-year average ROIC ≥9% but <20% and market capitalization >$2 billion in 1995.
3Excluding goodwill.

The pattern continues for companies with
a low ROIC 7 (Exhibit 3). Although
both ROIC and growth are still important,
an improvement in ROIC is clearly more
important: companies that increased their
ROIC generated, on average, a TRS 5 to
8 percent higher than those that didn’t.
Growth relative to the market made less
7 Those with a ten-year average ROIC in 1995
ROIC . This result isn’t surprising. Because
such companies were generating returns at
or below their weighted-average cost
of capital, they would have had difficulty
accessing capital to finance further growth
unless they improved their operations and
earned the right to grow. Indeed, nearly
one-third of the companies in this category

greater than or equal to 6 percent but less than

difference (1 to 4 percent) for shareholders, from 1995 were acquired or went bankrupt
9 percent. particularly if the company improved its within the following decade.

32 Role of the CFO: Selected readings for finance leaders

 Web 2007
Growth
Exhibit 3 of 3
 McKinsey on Financewith a low ROIC, improvement in Autumn 2007 more important than growth.
Glance: For companies ROIC is clearly
Exhibit title: Low ROIC

Exhibit 3
Low ROIC Total returns to shareholders (TRS)1 for companies with high returns on invested capital (ROIC),2
1996–2005, %
For companies with a low ROIC, improvement in Median TRS exceeds market
ROIC is clearly more important than growth.

Difference,
S&P 500 average = 6.9 percentage points

11 12

Increased 1

ROIC3

Decreased 7 4
3

Below Above

Growth, CAGR of revenues

Difference, 8 5
percentage points

1Median of compound average annual TRS from 1996 to 2005 for each group of companies, adjusted for compound
1996–2005 average TRS of S&P 500 index companies (6.9%).
264 companies with 10-year average ROIC ≥6% but <9% and market capitalization >$2 billion in 1995.
3Excluding goodwill.

Of course, when an industry reaches opportunities or improve its returns on

maturity and consolidates, companies may
find it impossible to avoid slow growth
and, at the same time, compressed margins.
And when a company cannot find growth
investment, executives might better serve
shareholders by selling the company to
owners who can drive higher growth or by
returning capital to shareholders through
stock buybacks. MoF

Bin Jiang (Bin_Jiang@McKinsey.com) is a consultant and Tim Koller (Tim_Koller@McKinsey.com) is a

partner in McKinsey’s New York office. Copyright © 2007 McKinsey & Company. All rights reserved.

33 Role of the CFO: Selected readings for finance leaders

2

Are you still the best owner

of your assets?
As companies rethink their portfolios for the post-crisis world, they should ask
themselves if they are still the best owners of their assets.

Richard Dobbs, As the post-crisis thoughts of executives turn to
Bill Huyett, and mergers, acquisitions, and disposals, the familiar
Timothy M. Koller
idea of “best owner” takes on renewed urgency.
Discerning readers will be well aware that best
owners are those companies whose distinctive
characteristics enable them to create more value
in a given business than other potential owners
could. But the pace of rapid recovery in equity
market valuations may be causing some executives
to worry too much about being preempted by
better-prepared competitors and too little about
acquiring businesses where they themselves
would hold a distinct advantage.
The risk is considerable. Reactivating deals that
were put on hold may be unwise in some industries
where fundamental changes during the crisis have
34 Role of the CFO: Selected readings for finance leaders
weakened the competitive position of deal targets
or hurt the structural attractiveness of their
markets. Companies may also discover that they
have lost competitive advantage in businesses
they already own. Moreover, boards and manage-
ment teams that assess the fundamental
attractiveness of their potential acquisitions and
disposals solely by growth and returns increase
the likelihood that they will enrich only the sellers
of the businesses they buy—or the buyers of the
businesses they sell.
If a board and management team want to create
the most value for their own shareholders, they
must be clear about how their company will
add more value to a business than other potential
owners can. If that isn’t the case, the company

1 It’s important to note that
these skills must exist
at the owner level—and that
owners must be able to
replicate them from business
to business. Such skills,
often derived from a deep
bench of product-
management talent, create a
competitive advantage in
M&A. Distinctive skills at the
business level could be
transferred to other owners.
might best serve the shareholders’ interests
by selling the business—or by not buying it in the
first place.
What makes a better owner?
In reality, we can never know who the very best
owner of a business might be; we can only
know who is probably the better owner among
competing alternatives. A better owner
could be a larger company, a private-equity firm,
a sovereign-wealth fund, or a family. It could
also be an independent public company listed on
a stock exchange, a mutual (owned by its
customers), or even a government- or employee-
owned entity. As better owners, each of these
types of companies may add value to a business
in a number of ways.
Valuable linkages with other businesses
The most straightforward way that owners add
value is through the links they can offer to other
businesses they own, especially when such links
are unique. Suppose, for instance, that a mining
company has the rights to develop a coal field
in a remote location far from any rail lines or other
infrastructure, except for those built by another
mining company, which already operates a coal
mine just ten miles away. The second mining
company might well be the better owner because
its incremental costs to develop the mine would
be lower than the first company’s. It could afford
to purchase the undeveloped mine at a higher
price and still earn an attractive returns on capital.
These unique links can occur across the value chain,
from R&D and manufacturing to distribution
and sales. A large pharmaceutical company with
an experienced oncology sales force might,
for example, be the best owner of a small pharma-
ceutical company with a promising new
oncology drug but no sales force or commer-
cialization capacity.
35 Role of the CFO: Selected readings for finance leaders
3
In most cases, these linkages (and the value they
create) are not unique to a single potential
owner. IBM, for example, has successfully acquired
dozens of small software companies to take
advantage of the power of its global sales force.
IBM as an owner was better able to sell the
products globally than the previous owners were.
Other companies, such as Oracle or SAP, may
also have been better owners; ultimately, the best
depends on both the theoretical potential—
the specific matches of products and sales forces—
and the effectiveness of postacquisition merger
management.
Distinctive skills
Better owners may also have distinctive and
replicable functional or managerial skills,1 which
can be found anywhere in the business system,
from product development to manufacturing
processes to sales and marketing. The skill set has
to be a driver of success in the industry, however.
A company with great manufacturing skills,
for example, probably wouldn’t be a better owner
of a consumer-packaged-goods business,
because manufacturing costs aren’t large enough
to affect its competitive position.
In contrast, distinctive skills in developing and
marketing brands often make a packaged-goods
company a better owner. Take P&G, which as
of 2009 had 20 brands with over $500 million
in net sales and 23 with over $1 billion, all
spread across a range of product categories,
including laundry, beauty products, pet food, and
diapers. Almost all of the billion-dollar brands
rank first or second in their respective markets.
What’s special about P&G is that it developed
these brands in different ways. Some, such as Tide
and Crest, have been P&G brands for decades.
Others, including Gillette and Oral-B, were
acquired during the past ten years, while a number,
such as Febreze and Swiffer, were developed
 4 McKinsey on Finance Number 34, Winter 2010
2 Joachim Heel and Conor
Kehoe, “Why some
private equity firms do
better than others,”
mckinseyquarterly.com,
February 2005. The authors
analyzed 60 successful
investments by 11 leading
private-equity firms.
3 Viral Acharya, Conor Kehoe,
and Michael Reyner, “The
voice of experience: Public
versus private equity,”
mckinseyquarterly.com,
December 2008.
from scratch. As a group, sales of these brands
grew by 11 percent a year, on average, from 2001
through 2009.
Better governance
Owners can also add value through better
governance of a business, without necessarily
having a hands-on role in its day-to-day
operations. Better governance refers to the way a
company’s owners interact with the manage-
ment team to create the greatest possible long-term
value—perhaps the way the owners appoint
managers, structure their incentives, or challenge
them on strategy. The best-performing private-
equity firms excel at governance—giving them a
crucial advantage over those that rely heavily
on financial leverage. Indeed, prior McKinsey
analysis found that in almost two-thirds of the
transactions of the top-quartile funds we examined,
improving the operating performance of a
company relative to its peers created more value
than financial leverage or good timing did.2
Better governance is a key source of this
outperformance. Private-equity firms don’t always
have the time or skills to run their portfolio
companies on a day-to-day basis, but they govern
these companies very differently from the way
listed companies do. Typically, private-equity firms
introduce a stronger performance culture and
36 Role of the CFO: Selected readings for finance leaders
are quick to bring in new managers when
necessary. In addition, they encourage managers to
abandon sacred cows and give those managers
leeway to focus on improvements over a five-year
horizon rather than the typical one-year time
line common among listed companies. Private-equity
directors also spend, on average, nearly three
times as many days on their roles than directors at
public companies do, and they spend most of those
days on strategy and performance management
rather than compliance and risk avoidance.3
Better insight or foresight
Companies that have insights into how a market or
industry will evolve may be better owners of
businesses that don’t even exist yet, if they can use
those insights to innovate and expand existing
businesses or to develop new ones. In the late
1990s, for example, Intuit noticed that many small
businesses were using its Quicken software,
originally designed to help individual consumers
manage their personal finances. That obser-
vation led to an important insight: most accounting
software was too complex for small-business
owners. So Intuit designed a new product for them
and within two years had claimed 80 percent of
this burgeoning market.
A decade earlier, the US oil and natural gas
concern Williams Companies had the foresight to
Are you still the best owner of your assets?
see that fiber-optic networks would be the future
of communications. But unlike other companies
that anticipated the shift, Williams had an additional
insight—and a key advantage: fiber-optic cable
could be installed in its decommissioned oil and
gas pipelines at a fraction of the cost its com-
petitors would have to pay for comparable infra-
structure. By combining its own network with
those it acquired from other companies that had
fiber-optic networks, Williams eventually
gained control of 11,000 miles of cable and could
send digital signals and natural gas from one
end of the country to the other.
Williams’s insight, combined with its pipeline
infrastructure, made it a good or best owner of this
network in the emerging digital-communications
industry. Williams also reduced its stake in fiber-
optic cable at the right time—when prices were
highly inflated: it sold most of its telecommuni-
cations business in 1994 for $2.5 billion.
Distinctive access to talent, capital, or
relationships
This category applies primarily to companies
in emerging markets, where running a business is
complicated by inherently smaller pools of
managerial talent, underdeveloped capital markets,
and high levels of government involvement in
business as customers, suppliers, and regulators.
In these markets, diversified conglomerates,
such as Tata and Reliance in India and Samsung
and Hyundai in South Korea, can be better
owners because their size, stability, and relatively
abundant opportunities make them more
attractive employers and because they have better
access to capital or distinctive relationships
with governments.
37 Role of the CFO: Selected readings for finance leaders
5
The best-owner life cycle
Better ownership is not permanent or static but
rather can change over the life cycle of a business.
Too many companies don’t recognize that even
if their own distinctive capabilities remain the same,
the needs of a business naturally change as it
matures and the industry it competes in changes.
Typically, a business’s founders are its first best
owners. Their entrepreneurial drive, passion,
and commitment to the business are necessary to
get the company off the ground. As it grows and
requires larger investments, a better owner may be
a venture capital firm that specializes in helping
new companies grow by providing capital, improving
governance, and enlisting professional managers
to handle the complexities and risks of scaling up
an organization. Eventually, the venture capital
firm may need to take the company public, selling
shares to a range of investors to finance further
growth. As the public company grows, it might find
that it can no longer compete with larger
corporations because, say, it needs global distri-
bution capabilities far beyond what it can
build in a reasonable amount of time. It may thus
sell itself to a larger company that’s the better
owner because of an existing global distribution
network, thereby becoming a product line within a
division of the larger company.
As the division’s market matures, the larger
company may decide to focus on faster-growing
businesses. In this case, it might sell its
division to a private-equity firm—a better owner if
the firm can eliminate corporate overhead that’s
inconsistent with the business’s slower growth and
thereby leave the division with a leaner cost
structure. Once the restructuring is done, the
 6 McKinsey on Finance Number 34, Winter 2010
private-equity firm can sell the division to yet
another better owner: a large company
that specializes in running slow-growth brands.
Managerial implications
The best-owner life cycle means that executives
must continually seek out new acquisitions
for which their companies could be the best owner
while at the same time divesting businesses for
which they no longer are. Since the best owner for
businesses constantly changes, any corporation,
large or small, should acquire and dispose of them
regularly. Indeed, companies that do so generally
outperform those that do not. 4
For acquisitions, applying the best-owner principle
often leads acquirers toward targets very different
from those that traditional target-screening
approaches might uncover. Traditional ones often
focus on targets that perform well financially
and are somehow related to the acquirer’s business
lines. But through the best-owner lens, such
characteristics might have little or no importance.
It might be better, for instance, to seek out a
financially weak company that has great potential
for improvement, especially if the acquirer has
proven performance-improvement expertise. Or it
might be better to focus attention on tangible
opportunities to cut costs or on the existence of
common customers than on vague notions such
as how related the target may be to the acquirer.
Keeping the best-owner principle front and center
can also help with negotiations for an acquisition
by keeping managers focused on what the target is
worth specifically to their own company—as well
4 Jay P. Brandimarte,
as to other bidders. Many managers err in M&A by
William C. Fallon, and
Robert S. McNish, “Trading estimating only an acquisition’s value to their
the corporate portfolio,”
mckinseyquarterly.com,
own company. Because they are unaware of the
October 2001. target’s value to other potential better owners—
38 Role of the CFO: Selected readings for finance leaders
or how high those other owners might be willing
to bid—they get lulled into conducting negotiations
right up to their breakeven point. Of course the
closer they get to it, the less value the deal would
create for their own shareholders. Instead of
asking how much they can pay, they should be
asking what’s the least they need to pay to win
the deal and create the most value.
Consider the example of an Asian company that
was bidding against a private-equity firm to
purchase a European contract pharmaceutical
manufacturer. The Asian company estimated
the target’s value to itself and also to the private-
equity firm, which could add value by reducing
overhead costs and attracting customers that hadn’t
used the target’s services because it was owned
by a competitor. The Asian company estimated that
the contract company was worth $96 million
to the private-equity firm.
The Asian company could make the same overhead
cost reductions and add similar customers—
but on top of this, it could move some of the manu-
facturing to its lower-cost plants. As a result,
the target’s value to the Asian company was
$120 million, making it the best owner and enabling
it to pay a higher price than the private-equity
firm would, while still allowing it to capture
significant value. As a side note, the value of the
target to its European parent was only $80 million.
Knowing the relative values, the Asian company
could afford to bid, say, $100 million, pushing
out the private-equity firm and gaining $20 million
in potential value creation. The Asian company
could further increase its share of the value to be
captured, by announcing plans to enter the
business even without making the acquisition. If
the seller and the private-equity firm were
 Are you still the best owner of your assets? 7

convinced, they would have to reduce their estimates
of the target’s value, and the Asian company
could reduce its bid, capturing more value still.
For divestitures, including both sales and spin-offs,
the best-owner principle allows managers to
examine how the needs of the businesses they own
may have evolved in different directions. For
example, most pharmaceutical companies grew up
as parts of diversified chemical companies
because the basic manufacturing and research
requirements were the same. But as the two
industries specialized, their research, manufac-
turing, and commercial requirements diverged
so much that they became distant cousins rather
than sisters.
ago, it no longer does. That is why nearly all
former chemical and pharmaceutical combines
have split up over the past three decades;
Zeneca, for example, separated from ICI in 1993,
and Clariant and Sandoz parted ways in 1995.
Executives may worry that divestitures are seen
as an admission of corporate failure or as a
consequence of a company’s relatively small size.
Yet the research shows that stock markets
consistently react positively to divestitures—both
sales and spin-offs.5 Research has also shown
that spun-off businesses tend to increase their
profit margins by one-third during the three
years after the completion of the transaction.6

5 Audra L. Boone and J.

Today, running a profitable commodity chemical
Harold Mulherin,
“Comparing acquisitions and
company demands scale, operating efficiency, To maximize value for shareholders, a company’s
divestitures,” Journal of and the ability to manage costs and capital expen- board and management team must be clear—
Corporate Finance, 2000,
Volume 6, Issue 2, pp. 117–39. ditures. But creating value in a pharmaceutical and current—about how they do or could add value
6 Patrick Cusatis, Lehman
company requires a deep R&D pipeline and large to each business in their portfolio. At the very
Brothers, James A. Miles, local sales forces, as well as specialized expertise least, they must understand what makes them the
and J. Randall Woolridge, in areas such as the regulatory-approval process best owner of what kinds of businesses and be
“Some new evidence
that spinoffs create value,” and dealing with large public and private prepared to act accordingly.
Journal of Applied
purchasers. While having both kinds of businesses
Corporate Finance, 1994,
Volume 7, Issue 2, pp. 100–7. under one owner made complete sense 50 years

The authors would like to thank Chris Bradley for his contributions to this article, as well as John Stuckey, who led
McKinsey’s earlier thinking on best ownership.

Richard Dobbs (Richard_Dobbs@McKinsey.com) is a partner in McKinsey’s Seoul office, Bill Huyett

(Bill_Huyett@McKinsey.com) is a partner in the Boston office, and Tim Koller (Tim_Koller@McKinsey.com) is a partner
in the New York office. This article is excerpted and adapted from the authors’ forthcoming book, Value: The Four
Cornerstones of Corporate Finance (Boston: John Wiley and Sons, 2010). Copyright © 2010 McKinsey & Company.
All rights reserved.

39 Role of the CFO: Selected readings for finance leaders

Applying lessons learned from restructuring

41 Maintaining a long term view in turnarounds

46 Leading companies out of crisis: Ten tips from a veteran turnaround artist

52 Can we talk? Five tips for communicating in turnarounds

40 Role of the CFO: Selected readings for finance leaders


Maintaining a long-term view
during turnarounds
Changing course demands an intense focus on short-term performance, but
success needn’t come at the expense of long-term value.
Kevin Carmody, Peter switched on his desk lamp. It was getting
Ryan Davies, and dark, and the past 11 hours had been full of
Doug Yakola
meetings and decisions. His trucking company
had been struggling with the high diesel prices
and soft economy of the early 2000s, but he had
been fighting back by cutting costs across
the board. He wasn’t failing yet, but he wasn’t
sure how long he could fend it off.
He opened an approval request on his desk for
the second time that week and read it again.
It was a multimillion-dollar purchase order for
retrofitting his entire fleet to natural gas.
Several months earlier, the decision had seemed
to be a no-brainer: his trucks could run on
natural gas for a fraction of the cost of diesel. In
41 Role of the CFO: Selected readings for finance leaders
9
© Dennis O’Clair/Corbis
a weak economy, the reduction in operating
costs would be welcome—and he’d be positioned
well to compete when the economy picked up.
But as he stared at the numbers, he now wondered
if it would still be the right move. The switch
to natural gas would require a host of difficult
organizational and operational changes—
even if some of them would free up much-needed
cash. He put down his pen and closed the file.
What he really needed, he realized, was a way to
more fundamentally turn things around.
Any leader who’s been through a turnaround
knows that driving one requires an intense
focus on delivering near-term results. Some moves
make obvious sense. Building value-creation
10 McKinsey on Finance Number 53, Winter 2015
metrics into a long-term vision and implement-
ing aggressive cash-management practices,
for example, can help fund restructuring while
avoiding existential crises down the road.1
Other moves are riskier. The short-term pressure
is so intense that many managers succumb to
myopic decision making that can hurt a company’s
long-term health or even sow the seeds of irre-
versible failure. Examples abound of companies
that survived a financial crisis by shutting off
all discretionary spending, only to fail later when
their operations became unreliable or required
considerable new investment. The damage in these
cases can exceed the impact of the initial financial
hit. Depriving an organization of continuous
investment in sustaining capital—whether in main-
tenance, growth and innovation, or people—can
result in dozens of other incidents, each individually
small and correctable but together adding
up to create an unreliable operation that hurts the
customer, the business, and its reputation.
The most successful turnarounds are those in
which managers balance the short and long term
in business decisions, both financially and
organizationally. Financially, many investments
that do not pay back their costs quickly (in less
than two years) still create value and are important
for the viability and health of the company.
There are rarely clear answers to such investment
decisions, but in our experience, a few tech-
niques can help ensure that you make the best
decisions with the information you have.
Avoid sweeping decrees
When faced with financial troubles, many
companies respond by ordering a freeze on all
spending, from capital spending to hiring,
travel, and other discretionary expenses. Such
moves can certainly be necessary in times
42 Role of the CFO: Selected readings for finance leaders
of distress. In most cases, however, it’s better to
take a more nuanced approach.
Managers should always discuss a company’s
largest investments individually, giving time and
attention to both the short-term and long-term
implications of delaying investment. Letting such
decisions fall under a broad spending directive
can have a devastating impact. One global manu-
facturing company whose operations relied
on substantial electrical power decided to delay
a scheduled transformer rebuild by a year
to save cash. Five months into the year, the trans-
former failed catastrophically, taking 20 percent
of production off line while the company built
and installed a replacement. Elsewhere, a trans-
portation company that delayed the scheduled
replacement of key logistical equipment suffered
a setback when the equipment failed, result-
ing in collateral damage to the physical plant
and equipment.
For smaller investments, it’s better to organize
spending into categories in which the implications
for long-term health can better be discussed and
understood. There is an important distinction, for
example, between repainting the hallways and
refurbishing an electrical transformer that a broad
proscription of spending on maintenance
would not recognize. Similarly, a hiring freeze
on executive assistants results in different
risks from a freeze on vehicle operators or
sales managers.
During one turnaround, executives at a consumer-
products company found that plant managers
historically had little discipline in spending—they
invested in projects without considering hurdle
rates or returns on the investment—and more than
350 projects would be affected by a spending
freeze. During the turnaround process, executives
 Maintaining a long-term view during turnarounds
worked alongside plant managers to weigh
the trade-offs between what was necessary to
serve customers and deliver products and
what could be delayed to reduce costs. Together,
they determined that nearly half of the planned
projects could be postponed. They then imple-
mented an aggressive program for working-capital
management to simplify inventory management,
approving spending that would help the business
grow in the short and medium term while
instituting strict internal controls on areas that
were less critical, such as overtime, excessive
travel, and some maintenance.2
Prioritize investments
Managers under pressure in turnaround situations
have little time to evaluate thoughtfully which
activities and investments to support and which to
cut. Often, decisions rest on which department
head has the most organizational clout, has the
strongest personality, or argues the loudest
to protect his own programs and people—an under-
standable but not particularly effective way of
making cuts.
A better approach we’ve seen companies take is to
make a list of all actions that would create near-
term cash, force ranked by the amount of damage
each would do to the long-term health of the
To prioritize investments, companies can make a list
of all actions that would create near-term cash,
force ranked by the amount of damage each would do
to the long-term health of the company.
43 Role of the CFO: Selected readings for finance leaders
11
company—typically prioritizing actions with
the highest net present value (NPV) at one end and
those with the most negative NPV at the other.
Such a list should be created and discussed very
early in a turnaround, and it must assess the
effect of divesting or discontinuing every activity
and selling every asset, with no exceptions. It
will only be complete when the last thing left to do
after taking every action on the list would be to
shut the doors. It’s a tough exercise to go through,
but it gets all the ideas on the table for discussion.
Highest on this list will be a number of immediate
actions that create little risk. Lower down will
be actions that begin to affect long-term growth
prospects or operational reliability. The trick
is to separate sources of real long-term damage
potential from threats of damage that are
merely perceived. This can be accomplished by
taking the time and effort to understand each
investment in depth and by making sure someone
is assigned to ask the tough questions.
It’s also a good idea to assign quantifiable metrics
to trigger the next cut on the list when a com-
pany comes within a certain number of months of
no longer having sufficient cash to pay its bills.
This creates a clear contingency plan in case things
turn worse. Just as important, it creates a clear
12 McKinsey on Finance Number 53, Winter 2015
understanding of the future health risk required to
stabilize the business in the short term.
If Peter, the manager discussed at the beginning
of this article, were to conduct this exercise,
he might find many actions he could take that are
higher on the list, with less long-term damage
than eliminating the natural-gas conversion project.
That could help him feel better about approving
it. The exercise would also give him an opportunity
to tighten the spending-approval interval so
that he would only approve the minimal spending
possible each time. This would ensure that
he could retain control of future financial invest-
ments in case things were to change and he
needed to take this more drastic action.
Discourage short-term actions with
negative long-term consequences
In any turnaround, increased accountability and
pressure on business-unit managers to hit
their numbers can exacerbate short-termism—
which often leads to decisions that create less
value for the company. They can be tempted, for
example, by any number of little ways to cheat.
Some tactics may incur purely financial risk, such
as conceding sales discounts to meet near-
term volume and margin goals or structuring
back-loaded or risky contracts. Others can
be more dangerous, such as allowing lower-quality
products to go to market, delaying a maintenance
outage until the next accounting period, or
continuing production despite safety or reliability
44 Role of the CFO: Selected readings for finance leaders
concerns. A manager at a global commodities
company, for example, hoped to catch up on
production by delaying the routine maintenance of
a piece of heavy equipment despite concerns
identified by engineers. The equipment failed not
long after, leading to a lengthy production
outage. The tension between execution and innova-
tion is worth special note. Innovation requires
experimentation and failure, which can be hard
to defend in an environment where every
dollar counts.
The challenge is to create urgency and account-
ability for near-term performance targets without
encouraging shortcuts that destroy value and
may have insurmountable negative consequences.
Some companies deal with this by protecting
people and budgets for strategically important
innovation, even while aggressively reducing
costs in other areas of the company. Others set
targets for near-term results and then outline
everything managers can do to meet those targets.
The most important approach is to explicitly
identify and understand the impact of every step
that’s part of the company’s ability to create value.
Invest in people
In our experience, the single largest attribute of a
successful turnaround and a healthy company
is the people who manage and run it. Yet, in many
cases, investment in people is one of the first
areas to go when companies struggle. Whether
that means pay freezes or cuts or the elimi-
Maintaining a long-term view during turnarounds 13

nation of benefits, training, or team-building
activities, such steps are often the easiest and
fastest way to save cash fast. More than one
company we know of dramatically reduced hiring
of entry-level leadership talent during the 2009
recession and now struggles with a gap in future
leaders at the middle levels of the organization.
Our view is that almost all of these moves will
affect a company’s long-term health. When
a business is struggling, companies count on their
employees even more than they do when it’s
healthy, whether to increase productivity, come
up with creative ideas, improve teamwork,
or simply provide moral support. Avoiding cuts
in this area for as long as possible sends a
message that people are valuable and will energize
staff to take part in the turnaround. To be clear,
it is important to continue to make case-by-case
decisions on talent, but avoiding across-the-
board cuts for people and benefits should be a
strong consideration.
1 Ryan Davies and David Merin, “Uncovering cash and insights
tools to understand what value creation means
and how it is measured. This can include training
on how to interpret financial statements and
how to calculate NPV, return on invested capital,
and economic profit. Incentives are obviously
important—ideally, performance evaluation is tied
to short-term results, with compensation linked
in some ways to equity in order to reflect long-term
value (particularly for senior leaders). Consis-
tently communicating the narrative is also critical,
as is role modeling by senior leaders.
Rapid performance transformation is hard to pull
off. And even if a company succeeds in deliver-
ing near-term results, creating value in the longer
term is an even higher bar. Turnaround leaders
should create a vision and a road map with
markers that keep both in mind—and lead their
teams in managing against these.

from working capital,” McKinsey on Finance, July 2014,

It is also crucial to support and encourage leaders mckinsey.com.
2 For more on such programs, see Davies and Merin, “Uncovering
to make hard decisions for the long term, even
cash and insights from working capital.”
at some risk to near-term results. This starts with
an aggressive education-and-awareness campaign
that provides the entire organization with the

Kevin Carmody (Kevin_Carmody@McKinsey.com) is a partner of McKinsey Recovery & Transformation

Services and is based in McKinsey’s Chicago office, Ryan Davies (Ryan_Davies@McKinsey.com)
is a principal in the New York office, and Doug Yakola (Doug_Yakola@McKinsey.com) is a senior partner
of McKinsey Recovery & Transformation Services and is based in the Boston office. Copyright © 2015
McKinsey & Company. All rights reserved.

45 Role of the CFO: Selected readings for finance leaders

2

Leading companies out of crisis:

Ten tips from a veteran turnaround artist
Even good managers can miss the early signs of distress, says Doug Yakola,
who’s been running recovery programs for 20 years. The first step is to acknowledge
there’s a problem.

“I’ve seen my share of boiled frogs,” says Doug
Yakola, comparing companies in crisis with the
metaphorical frog that doesn’t notice the
water it’s in is warming up until it’s too late.
As the chief restructuring officer or CFO
of more than a dozen turnaround situations over
nearly two decades, Yakola has witnessed
firsthand how managers back right into a crisis
without recognizing that their situation is
worsening. “They’re not bad managers, but
they’re often working under a set of paradigms
that no longer apply and letting the power
of inertia carry them along.” And if they don’t
realize they’re facing a crisis, they won’t
know that they need to undertake a turn-
around, either.
He’s also heard the regrets: sometimes managers
underestimated how critical their situation
was—or they were looking at the wrong data.
Others took advantage of easy access to
cheap capital to stay the course in spite of poor
performance, believing they could push
through it. Still others got so caught up in the
pressure for short-term returns that they
neglected to ensure their company’s long-term
health—or even willfully sacrificed it.
Rare among them is the executive who stepped
back to review his or her own plans objectively,
asking “Is this what I thought would happen when
I first started going down this road?” That’s
a problem, Yakola says, because acknowledging

46 Role of the CFO: Selected readings for finance leaders

 3

that your plan isn’t working is a necessary
first step.
Yakola joined McKinsey’s Recovery & Transforma-
tion Services as a senior partner in 2011. Here,
he offers ten ways ailing companies can get started
on the turnaround work they need.
dangerous to think that you have one for your own
company. Depending on the situation, there
are probably 25 different signs of potential distress
(exhibit). The problem is seldom made up of
just one or two of these things, however. Rather, it
is the result of a greater number of them inter-
acting together and with other external factors.

MoF 49
Throw 2013
away your perceptions of Force yourself to criticize your own plan
Leading
a companies
company in distressout of crisis: Ten tips from a veteran
The biggest thing turnaround artistdistress is
you can do to avoid
Exhibit
It’s next to impossible to come up with one working periodically review your business plans. When
definition of a company in distress—and you’re creating them, whether at the beginning of

Exhibit There are numerous signs of distress—and a distressed company

is typically dealing with multiple signs.

Working capital/liquidity Financial

• Declining or negative free • Declining stock price
cash flow • Declining bank or bond price
• Large contingent liabilities • Inability to meet debt covenants
• Unresolved near-term • Resignations of key finance staff
debt maturities • Diminishing liquidity
• Revolver drawdowns • Repeated bank amendments
• Contracting vendor terms • Downgrades in debt ratings
• Increase in accounts- • Accounting restatements
receivable aging • Inability to file financial
• Increase in outstanding statements
accounts payable
Signs of
distress
Profitability and Employees
industry outlook • Large or unplanned reductions
• Shrinking EBITDA1 margin in workforce
• Reduced capital-investment • Management turnover
programs • Disruption in unionized
• Going-concern opinion workforce
• Deteriorating industry
fundamentals
• Adverse regulatory environment
• Regulatory inquiries

1 Earnings before interest, taxes, depreciation, and amortization.

47 Role of the CFO: Selected readings for finance leaders

4 McKinsey on Finance Number 49, Winter 2014
the year or the start of a three-year cycle, build
in some trigger points. A simple explicit reminder
can be enough: “If we don’t have this type of
performance by this date or we haven’t gotten the
following 12 things done by this date, we’ll step
back and decide if we’re going down the right path,
given what’s happened since our last review.”
Such trigger points should be oriented both to
operational and market performance as well as to
basic financial metrics and cash flow. Look at
where you are as a company using basic financial
and cash milestones, and then look at where you
are with respect to your industry and competitors.
If you’re not moving with the rest of the industry
(or not outpacing it, if the industry is struggling),
then your plan may be obsolete. And don’t forget to
look back at your performance over past cycles
to identify any trends. If you keep missing perfor-
mance targets, ask why.
Expect more from your board
The beauty of a board is that it has enough
distance from the company to see the forest for
the trees. Managers often treat their board as
a necessary evil to placate so they can get on with
their business, but that undermines the board’s
role as an early-warning system when a company
is heading for distress.
48 Role of the CFO: Selected readings for finance leaders
It’s also the board’s responsibility to look the CEO,
the CFO, and the chief operating officer in the
eye and say, “OK, we like your plan. Now let’s talk
about what it would take to cut costs not just by
3 percent but by 20. Let’s talk about all the things
that can go wrong—the risks to the business.”
Sometimes significant events happen that no one
could have foreseen, of course. But in a typical
distress situation, a company has usually just had
18 to 24 months of poor performance, and the
board hasn’t been aware or hasn’t asked the right
questions. Independent board members—truly
independent ones—can have a big impact here.
The senior team at one company maintains a list
of risks to the business, employees, and the plan.
They review those risks with the board on a
quarterly basis to ensure that they’re staying top
of mind. It’s an excellent way to have conversa-
tions that you wouldn’t normally otherwise have in
a business operation.
Focus on cash
A successful turnaround really comes down to
one thing, which is a focus on cash and cash returns.
That means bringing a business back to its basic
element of success. Is it generating cash or burning
it? And, even more specifically, which investments
in the business are generating or burning cash?
 Leading companies out of crisis: Ten tips from a veteran turnaround artist
Nasty surprises await when no one is focused on cash—
and keeping track of cash isn’t just about watching your
bank balance.
I like to think about this in the same way one
would if running a local hardware store. By that, I
mean asking fundamental questions, such as
whether there is enough cash in the register to pay
the utility bill, for example, or to pay for the
pallet of house paint that will arrive next week, or
how much more cash I can make by investing
in a new delivery truck. When you bring a business
back to those basic elements, the actions you
need to take to get back on track become pretty
clear. In many of the cases I have seen, the
management team and board are focused on
complex metrics related to earnings before
interest and taxes (EBIT) and return on investment
that exclude major uses of cash. For example,
variations on EBIT commonly exclude depreciation
and amortization but also exclude things like
rents or fuel. These are all fine metrics, but nasty
surprises await when no one is focused on cash.
Keeping track of cash isn’t just about watching
your bank balance. To avoid surprises, companies
also need a good forecast that keeps a midterm
and longer view. For example, failing to pay atten-
tion to the cash component of capital investments
routinely gets companies in trouble. Project
net present values can look the same whether the
return begins gradually at year two or jumps up
dramatically at year five. But if you’re not focusing
on the cash that goes out the door while you’re
waiting for that year-five infusion, you can suddenly
find yourself with very little cash left to run
the business, sending you into a spiral you may
not recover from.
49 Role of the CFO: Selected readings for finance leaders
5
Create a great change story
Companies in distress don’t focus enough on
creating a change story that everyone understands—
and that creates some sense of urgency. Here’s
an example. I recently did a turnaround as chief
restructuring officer of a mining company. It
was profitable, returned a decent margin, and was
cash positive. But the commodity price was
dropping, and the board was worried about gener-
ating enough free cash flow to drive the capital
needs of the business. The change story we created
said, “Yes, we are profitable. But the whole point
of profitability is to generate enough cash to
expand, grow, and maintain operations. If we can’t
do that, then we’re headed for a long, slow
decline where equipment breaks down and lower
production becomes the new reality.”
If you can tell that story in a paragraph or less, in a
way that means something to the average guy on
the front line, then people will get on board. In this
case, employees wanted to have their children
and their grandchildren work for this company in
the same remote mining location, and the change
story spurred them to action. The key was a simple
message, not fancy metrics.
Treat every turnaround like a crisis
Without a crisis mind-set, you get a stable com-
pany’s response to change: risk is to be avoided, and
incrementalism takes over. Your workers are asked
to do a little more (or the same) with less. More
aggressive ideas will be analyzed ad nauseam, and
the implementation will be slow and methodical.
6 McKinsey on Finance Number 49, Winter 2014
In contrast, a crisis demands significant action,
now, which is what a distressed company needs.
Managers need to use words like crisis and
urgency from the first moment they recognize the
need for a turnaround. A company that’s in
true crisis will be willing to try some things that it
normally wouldn’t consider, and it’s those bold
actions that change the trajectory of the company.
Crisis drives people to action and opens managers
up to consider a full range of options.
Build traction for change with quick wins
The tendency of most managers is to put all of their
focus and resources into three or four big bets
to turn a company around. That can be a high-risk
approach. Even if big bets are sometimes
necessary, they take a lot of time and effort—and
they don’t always pay off. For example, say you
decide to change suppliers of raw materials so you
can source from a low-cost country, expecting
30 percent lower direct costs. If you realize six
months later that the material specifications
don’t meet your needs, you’ll have spent time you
don’t have, perhaps interrupted your whole
production schedule, and probably burned a bunch
of cash on something that didn’t pay off.
In addition to going after big bets, managers
should focus on getting a series of quick wins to
gain traction within the organization. Such
quick wins can be cost focused, cutting off demand
for some external service they don’t need.
Or it could be policy focused, such as introducing
a more stringent policy on travel expense.
Not only do such moves improve the bottom line,
they also generate support among employees.
In any given company, you’re likely to find that a
fifth of employees across the organization are
almost always supportive. They work hard. And
they will change what they’re doing if you just
50 Role of the CFO: Selected readings for finance leaders
ask them. These are the people you’ll want to
spend most of your time with, and they’re
the ones you’ll promote—but you’ll probably
spend too much time with the bottom fifth
of employees. These are the underachieving ones
who actively resist change, look for ways to
avoid it, or are simply high maintenance.
What often gets ignored is the remaining 60 percent
of the organization. These are the fence-sitters,
and they are tuned into action, not just talk. They
see the changes going on, and if you proactively
work with them, then 80 percent of the organiza-
tion will be behind you. But if you don’t give
them a reason to stand up and be positive about
the company, they’ll go negative. That’s the
importance of quick wins. When you quickly take
real action, and when those actions affect
the management team as well, you send a power-
ful message.
Throw out your old incentive plans
Management incentives are often the most
overlooked tool in a turnaround. In stable compa-
nies, short-term incentive plans can be a
complex assortment of goals related to safety,
financial and operational performance, and
personal development. Many are so complex that
when you ask managers what they need to
do to earn their bonus, many just shrug their
shoulders and say, “Someone will tell me
at the end of the year.”
In a turnaround, take a lesson from the private-
equity industry and throw out your old plans.
Instead, offer managers incentives tied specifically
to what you want them to do. Do you need $10
million of improvement from pricing? Then make
it a big part of your sales staff’s incentive plan.
Need $150 million from procurement? Give your
chief purchasing officer a meet-or-beat target.
Leading companies out of crisis: Ten tips from a veteran turnaround artist 7

Be willing to forgo bonus payments for those that
don’t achieve 100 percent of their target—and
to pay out handsomely for those whose results are
beyond expectations.
Replace a top-team member—or two
Experience tells me that most successful
turnarounds involve changing out one or two
top-team members. This isn’t about “bad”
managers. In my 20 years of doing this, I’ve only
seen a small handful of managers I thought
were truly incompetent. But it’s a practical reality
that there are managers who must own the
decline. And more often than not, they are inca-
pable of the shift in mind-set needed to make
fundamental changes to the operating philosophy
they’ve believed in for years. Whether they
realize it or not, they block that change because
they’re bent on defending what they believe
to be true. Although it’s difficult, removing those
people sends another signal to your stakeholders
that there will be changes and you’re not afraid to
make tough moves.
to understanding the impact of potential changes
on the business. Many times they are the
disgruntled ones, unhappy with the company’s
performance. But you need people who are
willing to point out the uncomfortable truths.
A turnaround is also a real opportunity to find
the next level of talent in an organization. I’ve been
through multiple crises where the people who
added the most value and impact weren’t the ones
sitting around the table at the beginning. I have
often found great leaders two and three levels
down who are just waiting for an opportunity—and
the fact that they can be part of something
bigger than themselves, saving a company, is often
enough to attract and retain them.
For both groups, it’s important to realize that
retention isn’t always about money and bonuses.
It’s also about figuring out the individual’s
needs. Good turnaround managers actively
look for those people and find a way to get
them involved.

Find and retain talented people

Beyond the leadership team, there are two types of
people I look for immediately. First are those
that have the institutional knowledge. They may
not be your top performers, but they know
all the ins and outs of the company—and are vital

The editors would like to thank Ryan Davies and Bill Huyett for their contributions to this article.

Doug Yakola (Doug_Yakola@McKinsey.com) is a senior partner in McKinsey Recovery & Transformation

Services, which focuses on turnarounds and financially distressed companies. Copyright © 2014 McKinsey &
Company. All rights reserved.

51 Role of the CFO: Selected readings for finance leaders

14 McKinsey on Finance Number 52, Autumn 2014
Can we talk? Five tips for
communicating in turnarounds
In tough times, investors scrutinize every detail. Here’s how to manage the discussion.
Ryan Davies, Few challenges are as daunting for investor
Laurent Kinet, and relations as communicating with investors in the
Brian Lo
middle of a restructuring. Managers of public
companies need to reckon with heightened scrutiny
of reporting and regulatory disclosures. Those
in private equity–owned companies face rigorous
performance dialogues about management.
And while doing so, managers in a turnaround must
simultaneously convey a sense of humility
about what went wrong and confidence that they
know how to correct it.
Whether the turnaround takes the form of
a formal restructuring or a strategic redirection,
investors will cast a gimlet eye on the
slightest nuances of every statement, report,
52 Role of the CFO: Selected readings for finance leaders
© AID/amanaimages/Corbis
public appearance, and performance metric for
signs of strength or weakness. Competitors
will cast any hesitation and ambiguity in the
most ominous terms, the better to win over
customers, suppliers, and key employees. And,
of course, all these challenges come at
once, just when managing the core business
is most difficult.
As with most complex situations, there is
no one-size-fits-all approach to communicating
during turnarounds. But our work suggests
that some general rules of thumb for investor
communications can be refined for these
particularly difficult discussions. By adopting an
investor’s point of view, monitoring shifts in

the shareholder base, targeting specific future
milestones, working to rebuild credibility, and
branding the turnaround, management
can better maintain focus and shore up critical
investor support.
1. Communicate from an investor’s
point of view
A successful turnaround requires input and
collaboration with a wide range of stakeholders,
such as owners (investors), the board of
directors, employees (including unions and work
councils where relevant), customers, suppliers,
government bodies, and communities. Communi-
cating early and often is crucial to create a
consistent narrative and convince stakeholders
that the turnaround is a winning proposition
for all involved.
But investors hold the purse strings. If they
recognize a company’s progress and reward it
with a higher share price, employees may
well be encouraged to double down on their
efforts. Conversely, if the investors’ view
of a company remains glum for too long, it can
dampen morale, lead to defections, and
ultimately undermine the viability of the entire
turnaround. Weak performance can also lead
to a decline in share price that can open the door
to an attack by activists or a takeover bid at far
less than the intrinsic value of a business. In that
environment, no news is usually considered
bad news. Lack of communication can accelerate
this process and its risks.
Moreover, communications with investors should
set the tone for discussion with all audiences.
It can be tempting to tailor messaging heavily for
different stakeholders. But in our experience,
this only adds complexity, conflicting narratives,
and risks. We’ve seen some cases end quite
53 Role of the CFO: Selected readings for finance leaders
15
badly when the company mixed up what it told to
whom, when messages for internal manage-
ment leaked to investors or other stakeholders
(such as unions), or when messages intended
for external audiences confused employees about
company priorities.
2. Watch for shifts among
core shareholders
Even in the best of times, prudent managers
devote energy to understanding how their most
important shareholders view and value a
company. These “intrinsic” investors base their
decisions on a deep understanding of a com-
pany’s strategy, its performance, and its potential
to create long-term value. Because they are
focused on a company’s long-term intrinsic value,
they are more likely than shorter-term investors
to support management through a turnaround1—
and most likely to move the company’s stock
price as it evolves.2 In our experience, shifts in
this base of investors nonetheless can occur
more dramatically in turnaround situations than
when companies are struggling, which can
be a harbinger of the likely difficulty of the
turnaround ahead.
Thorough analysis of such investors can help
managers assess the likely impact of various
improvements. Interviews by external agents, such
as communications or public-relations firms,
can be particularly helpful to tease out pain points.
It is then management’s task to address those
points head on and not try to hide the real issues
behind platitudes and pleasing statements.
One natural-resources company’s shareholders, for
example, acknowledged and complimented
management’s efforts to address specific hot-
button issues that had come up during interactions
among managers, the board of directors, and
top shareholders.
16 McKinsey on Finance Number 53, Winter 2015
Managers should make a point of being as candid as
possible from the start. It’s a well-established principle
of politics, but it’s just as applicable to companies
in a turnaround.
3. Express a specific vision for the future
A company undergoing a turnaround must paint a
detailed and compelling strategic vision of its plans
to address the root cause of underperformance
or distress. For one electricity and gas utility, this
meant recognizing shortcomings in its capital
discipline and committing not only to improve
return on investment but also to deliver short-term
results. For a payments company, it meant
reducing fragmentation in the core business by
properly integrating ten prior acquisitions that
had tripled the size of the company, rationalizing
facilities and SKUs, and building a new and
more efficient central support structure.
The vision should also include high-level financial
goals, with an outline of how they will be met.
Companies should be candid about the trade-offs
they’re making, for example, between captur-
ing savings to improve the bottom line in the short
term and reinvesting in the business to sustain
performance after the turnaround effort is
complete. In our experience, investors understand
that reinvestment is an important part of long-
term value creation—and they are supportive, as
long they understand the investments managers
are making and when they expect returns.
While getting too specific on timing can backfire,
investors typically value, and in some cases
demand, some sort of concrete guidepost. For
example, one high-tech company set a mid-
54 Role of the CFO: Selected readings for finance leaders
term goal of growth in earnings margin of between
17 and 19 percent, and it regularly referred to
progress toward that goal in reports and
during earnings calls. One company in a cyclical
industrial business, which had been earning
returns below its cost of capital for five years, set
a bold goal of return on invested capital at
or above the cost of capital, even at the low point
of the cycle—and it gave rough magnitudes
of the cost and margin improvements it expected
from its largest divisions to get there.
4. Rebuild credibility
Until managers of underperforming companies
earn back credibility with investors, their valuations
are unlikely to reflect more than a heavily
discounted version of the improvements manage-
ment is claiming. Regaining trust—both to
demonstrate open and honest transparency and,
frankly, to inspire confidence that managers
know what they’re doing—requires a change in
tack from usual communications on a number
of fronts.
Break all the bad news at once. As a general rule,
managers should make a point of being as
candid as possible from the very start. It’s a well-
established principle of politics, but it’s just as
applicable to companies in a turnaround. A new
management team has a great opportunity to
acknowledge all past mistakes and start with a
fresh slate. For example, one industrial com-
Can we talk? Five tips for communicating in turnarounds
pany’s stock actually rose the day it announced
a write-off of more than $1 billion, since investors
viewed this as a signal that the new manage-
ment team would make a decisive break from the
mistakes of the past and would make hard
decisions to exit dead-end investments that were
still absorbing capital and management time.
For an existing management team, the task is even
more daunting. It takes strong leadership to
criticize one’s own actions, sometimes at the risk of
being replaced. Investors may be more patient
at the outset of a turnaround while they await evi-
dence that the turnaround is working. But
the patience of even the most committed intrinsic
investor will wear thin if bad news just keeps
dribbling out.
Build a track record of delivery. Communicate
only the goals you know you can achieve—using
metrics and milestones you revisit regularly—
and then prove you can achieve them. Credibility is
at a premium in a turnaround—and nothing
erodes it like making a promise and falling short.
Metrics do not need to be purely financial. For
example, one mining company that had consis-
tently missed its financial and output targets
focused its turnaround goals on progress against
operational metrics, such as overall equipment
55 Role of the CFO: Selected readings for finance leaders
17
effectiveness, to demonstrate tangible performance
improvement. While such operational metrics
were not directly linked to top-line performance,
they offered investors a way to track managers’
performance and hold them accountable
for improvements.
Tie incentives to targets. Talk is cheap, and sophis-
ticated investors gravitate to management
teams that put their money where their mouth
is. Structuring compensation packages to
directly tie them to turnaround targets, as well as
having executives and board members buy
meaningful amounts of stock in a company, signals
a commitment and confidence to follow through
and deliver on a management team’s promises.
One company unveiled a new turnaround incentive
plan that aligned incentives for management
and frontline employees using similar performance
metrics. Investors reacted positively, citing
this as an example of the company’s focus and
commitment to turning a new page and a
reason for holding on to their current position.
Increase transparency. Just as breaking bad news
all at once can improve credibility in a turnaround,
candor can help not only at the level of overall
financial guidelines but also of specific projects.
18 McKinsey on Finance Number 53, Winter 2015

We’ve seen two different basic-materials
companies make a practice of detailing, during
earnings calls and investor gatherings, 10 to
20 projects for improving operational efficiency
and their impact on cash generation and
workforce behavior. Investors noted that they
appreciated the more vivid picture of the
type of transformation the companies were
undergoing and added that the observed
margin improvements had come from more
promising and sustainable sources than
shortsighted cost reduction.
Be confident—and humble. Managers must exude
confidence at their ability to withstand challenging
times from markets and competitors, as well as
project the success of the company’s planned turn-
around. But they also need to show humility in
the face of distress, whether it’s due to past under-
performance or external factors. Shareholders
will examine word choice and tone for signs of the
kind of arrogance and overconfidence that come
from denying past missteps.
5. Brand the turnaround
To many executives, branding a turnaround may
1 Robert N. Palter, Werner Rehm, and Jonathan Shih,
seem to be mere marketing, but it can be
“Communicating with the right investors,” McKinsey Quarterly,
an effective way to crystallize a focal point and
2 Sell-side analysts should not be disregarded, but more often
amplify the narrative for the outside world—
making the rebuilding effort more credible. One
mining company, for example, gave a pithy name
to its transformation effort and mentioned
it in every external communication. Soon after,
investors and media alike were citing the
project by name as shorthand for the company’s
promising turnaround, rendering internal
and external communication more coherent
and giving employees’ internal efforts some
external recognition.
A brand can also convey a sense of new beginning.
Attaching a campaign name to write-offs,
exits from failed ventures, and even mundane
PowerPoint templates for earnings-call slides
can reinforce a consistent and compelling change
story and build critical momentum.
Ultimately, communication is not a substitute
for performance. Nothing drives a stock price like
beating expectations and punishing short sellers
quarter after quarter. But a thoughtful approach to
communicating to investors and other stake-
holders can help managers build the momentum
they need to bring a struggling company into
a new era of value creation.
April 2008, mckinsey.com.
than not we see CFOs overinvest time and energy with analysts
relative to intrinsic investors.

Ryan Davies (Ryan_Davies@McKinsey.com) is a principal in McKinsey’s New York office, Laurent Kinet
(Laurent_Kinet@McKinsey.com) is a principal in the Shanghai office, and Brian Lo (Brian_Lo@McKinsey.com)
is a vice president of McKinsey Recovery & Transformation Services and is based in the New York office.
Copyright © 2015 McKinsey & Company. All rights reserved.

56 Role of the CFO: Selected readings for finance leaders

Dynamic resource allocation and eliminating
bias in decision-making
58 How to put your money where your strategy is

69 Overcoming a bias against risk

74 Zero-based budgeting: Five myths and realities

78 The return of zero-base budgeting

57 Role of the CFO: Selected readings for finance leaders

M A R C H 2 012

s t r a t e g y p r a c t i c e

How to put your

money where your
strategy is
Stephen Hall, Dan Lovallo, and Reinier Musters

Most companies allocate the same resources

to the same business units year after
year. That makes it difficult to realize strategic
goals and undermines performance.
Here’s how to overcome inertia.

Picture two global companies, each operating a range of

different businesses. Company A allocates capital, talent, and research
dollars consistently every year, making small changes but always
following the same broad investment pattern. Company B continually
evaluates the performance of business units, acquires and divests
assets, and adjusts resource allocations based on each division’s relative
market opportunities. Over time, which company will be worth more?

If you guessed company B, you’re right. In fact, our research suggests

that after 15 years, it will be worth an average of 40 percent more than
company A. We also found, though, that the vast majority of companies
resemble company A. Therein lies a major disconnect between the
aspirations of many corporate strategists to boldly jettison unattractive
businesses or double down on exciting new opportunities, and the
reality of how they invest capital, talent, and other scarce resources.

For the past two years, we’ve been systematically looking at corporate
resource allocation patterns, their relationship to performance, and the
implications for strategy. We found that while inertia reigns at most

58 Role of the CFO: Selected readings for finance leaders

 2

companies, in those where capital and other resources flow more readily
from one business opportunity to another, returns to shareholders
are higher and the risk of falling into bankruptcy or the hands of an
acquirer lower.

We’ve also reviewed the causes of inertia (such as cognitive biases and
politics) and identified a number of steps companies can take to
overcome them. These include introducing new decision rules and
processes to ensure that the allocation of resources is a top-of-mind
issue for executives, and remaking the corporate center so it can provide
more independent counsel to the CEO and other key decision makers.

We’re not suggesting that executives act as investment portfolio

managers. That implies a search for stand-alone returns at any cost
rather than purposeful decisions that enhance a corporation’s long-
term value and strategic coherence. But given the prevalence of stasis
today, most organizations are a long way from the head-long pursuit
of disconnected opportunities. Rather, many leaders face a stark choice:
shift resources among their businesses to realize strategic goals or
run the risk that the market will do it for them. Which would you prefer?

Weighing the evidence

Every year for the past quarter century, US capital markets have issued
about $85 billion of equity and $536 billion in associated corporate
debt. During the same period, the amount of capital allocated or reallo-
cated within multibusiness companies was approximately $640 billion
annually—more than equity and corporate debt combined.1 While most
perceive markets as the primary means of directing capital and
recycling assets across industries, companies with multiple businesses
actually play a bigger role in allocating capital and other resources
across a spectrum of economic opportunities.

To understand how effectively corporations are moving their resources,

we reviewed the performance of more than 1,600 US companies
between 1990 and 2005.2 The results were striking. For one-third of the

1 See Ilan Guedj, Jennifer Huang, and Johan Sulaeman, “Internal capital allocation and firm

performance,” working paper for the International Symposium on Risk Management and
Derivatives, October 2009 (revised in March 2010).
2 We used Compustat data on 1,616 US-listed companies with operations in a minimum of two

distinct four-digit Standard Industrial Classification (SIC) codes. Resource allocation

is measured as 1 minus the minimum percentage of capital expenditure received by distinct
business units over the 15-year period. This measure captures the relative amount of capital
that can flow across a business over time; the rest of the money is “stuck.” Similar results were
found with more sophisticated measures that control for sales and asset growth.

59 Role of the CFO: Selected readings for finance leaders

Q2
3 2012
Resource allocation
Exhibit 1 of 3

Exhibit 1
Capital allocations were essentially fixed for roughly one-third
of the business units in our sample.

Correlation index of business units’ capital expenditures,

year-over-year change,1990–2005 Companies’ degree of
capital reallocation
1.0 Low

0.9 Medium

0.8 High

0.7
The closer the correlation
0.6 index is to 1.0, the less the
year-over-year change in a
0.5 company’s capital allocation
across business units.
0
1991 1993 1995 1997 1999 2001 2003 2005

businesses in our sample, the amount of capital received in a given year

was almost exactly that received the year before—the mean correla-
tion was 0.99. For the economy as a whole, the mean correlation across
all industries was 0.92 (Exhibit 1).

In other words, the enormous amount of strategic planning in cor-

porations seems to result, on the whole, in only modest resource shifts.
Whether the relevant resource is capital expenditures, operating
expenditures, or human capital, this finding is consistent across indus-
tries as diverse as mining and consumer packaged goods. Given
the performance edge associated with higher levels of reallocation, such
static behavior is almost certainly not sensible. Our research showed
the following:

• Companies that reallocated more resources—the top third of our

sample, shifting an average of 56 percent of capital across business
units over the entire 15-year period—earned, on average, 30 percent
higher total returns to shareholders (TRS) annually than com-
panies in the bottom third of the sample. This result was surprisingly
consistent across all sectors of the economy. It seems that when
companies disproportionately invest in value-creating businesses,
they generate a mutually reinforcing cycle of growth and further
investment options (Exhibit 2).

60 Role of the CFO: Selected readings for finance leaders

 4

• Consistent and incremental reallocation levels diminished the

variance of returns over the long term.

• A company in the top third of reallocators was, on average,

13 percent more likely to avoid acquisition or bankruptcy than low
reallocators.

• Over an average six-year tenure, chief executives who reallocated

less than their peers did in the first three years on the job were
significantly more likely than their more active peers to be removed
in years four through six. To paraphrase the philosopher Thomas
Hobbes, tenure for static CEOs is likely to be nasty, brutish, and,
above all, short.

We should note the importance of a long-term view: over time spans

of less than three years, companies that reallocated higher levels
of resources delivered lower shareholder returns than their more stable
peers did. One explanation for this pattern could be risk aversion on
the part of investors, who are initially cautious about major corporate
capital shifts and then recognize value only once the results become
visible. Another factor could be the deep interconnection of resource
allocation choices with corporate strategy. The goal isn’t to make
dramatic changes every year but to reallocate resources consistently
over the medium to long term in service of a clear corporate strategy.
That provides the time necessary for new investments to flourish, for
established businesses to maximize their potential, and for capital
from declining investments to be redeployed effectively. Given the rich-
Q2 2012
ness and complexity of the issues at play here, differences in the
Resource between
relationship allocation
short- and long-term resource shifts and finan-
Exhibit
cial 2 of 3 is likely to be a fruitful area for further research.
performance

Exhibit 2
Companies with higher levels of capital reallocation
experienced higher average shareholder returns.

Companies’ degree of Total returns to shareholders,

capital reallocation compound annual growth rate,
(n = 1,616 companies) 1990–2005, %

High 10.2

Medium 8.9

Low 7.8

61 Role of the CFO: Selected readings for finance leaders

5

Why companies get stuck

Why do so many companies undermine their strategic direction by

allocating the same levels of resources to business units year after year?
The reasons vary widely, from the very bad—companies operating on
autopilot—to the more sensible. After all, sometimes it’s wise to persist
with previously chosen resource allocations, especially if there are no
viable reallocation opportunities or if switching costs are too high. And
companies in capital-intensive sectors, for example, often have
to commit resources more than five years ahead of time to long-term
programs, leaving less discretionary capital to play with.

For the most part, however, the failure to pursue a more active allocation
agenda is a result of organizational inertia that has multiple causes. We’ll
focus here on cognitive biases and corporate politics, but regardless of
source, inertia’s gravitational pull is strong—and overcoming it is critical
to creating an effective corporate strategy. As author and Kleiner Perkins
Caufield & Byers partner Randy Komisar told us, “If corporations don’t
approach rebalancing as fiduciaries for long-term corporate value,
their life span will decline as creative destruction gets the better of them.”

Cognitive biases
Biases such as anchoring and loss aversion, which are deeply rooted in the
workings of the human brain and have been much studied by behavioral
economists, are major contributors to the inertia that prevents more active
reallocation.3 Anchoring refers to the tendency to use any number, even
an irrelevant one, as an anchor for future choices. Judges asked to roll a
pair of dice before making a simulated sentencing decision, for example,
are influenced by the result of that roll, even though they deny they are.

Within a company, last year’s budget allocation often serves as a ready,

salient, and justifiable anchor during the planning process. We know
this to be true in practice, and it’s been reinforced for us recently as we’ve
played a business game with several groups of senior executives. The
game asked participants to allocate a capital budget across a fictitious
company’s businesses and provided players with identical growth
and return projections for the relevant markets. Half of the group also
received details of the previous year’s capital allocation. Those without
last year’s capital budget all allocated resources in a range that optimized
for the expected outlook in market growth and returns. The other
half aligned capital far more closely with last year’s pattern, which had
little to do with the potential for future returns. And this was a
game where the company was fictitious and no one’s career was at risk!
3 See Dan Lovallo and Olivier Sibony, “The case for behavioral strategy,” mckinseyquarterly.com,

March 2010.

62 Role of the CFO: Selected readings for finance leaders

 6

In reality, anchoring is reinforced by loss aversion: losses typically hurt

us at least twice as much as equivalent gains give us pleasure. That
reduces the appetite for taking risks and makes it painful for managers
to give up resources.

Corporate politics
A second major source of inertia is political. There’s often a tight align-
ment between the interests of senior executives and those of their
divisions or business units, whose ability to attract capital can signifi-
cantly influence the personal credibility of a leader. Indeed, because
executives are competing for resources, anyone who wins less than he
or she did last year is invariably seen as weak. At the extreme, leaders
of business units and divisions see themselves as playing for their own
“teams” rather than for the corporation as a whole, making it challeng-
ing to reallocate resources significantly. Even if a reduction in resources
to their division benefits the company as a whole, ambitious leaders
are unlikely to agree without a fight. As one CEO told us: “If you’re asking
Q2 2012
me to play Robin Hood, that’s not going to work.”
Resource allocation
Exhibit 3 of 3

Exhibit 3

Inertia may affect the distribution of other scarce resources,

such as advertising spending.

Correlation between each brand’s 2010 advertising budget and its average advertising
budget for previous 5 years at one consumer goods company (n = 40 brands)

Average advertising spending by brand

over 5 years, 2004–09, % of corporate total

5.0
r 2 = 0.87
4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0
0 0.5 1.0 1.5 2.0 2.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0
Average advertising spending by brand in 2010, % of corporate total

r2 is the measure of interdependence of 2 or more variables.

63 Role of the CFO: Selected readings for finance leaders

7

Overcoming inertia

Tempting as it is to believe that one’s own company avoids these traps,

our research suggests that’s unlikely. Our experience also suggests, though,
that taking steps such as those described below can materially improve
a company’s resource allocation and its connection to strategic priorities.
These imperatives apply not just to capital but also to other scarce
resources, such as talent, R&D dollars, and marketing expenditures (as
shown in Exhibit 3, for advertising spending by one consumer goods
company). All of these also are subject to the forces of inertia, which can
undermine an organization’s ability to achieve its strategic goals.
Consider one company we know that prioritized expanding in China. It
set an ambitious sales growth target for the country and planned to
meet it by supplementing organic growth with a series of acquisitions. Yet
it identified just three people to spearhead this strategic imperative—
a small fraction of the number required, which is typical of the problems
that arise when the link between corporate strategy and resource
allocation is weak. Here are four ideas for doing better.

1. Have a target corporate portfolio.

There’s a quote attributed to author Lewis Carroll: “If you don’t know
where you are going, any road will take you there.” When it comes to
developing an allocation agenda, it’s helpful to have a target portfolio in
mind. Most companies resist this, for understandable reasons: it requires
a lot of conviction to describe planned portfolio changes in anything
but the vaguest terms, and the right answers may change if the broader
business environment turns out to be different from the expected one.

In our experience, though, a target portfolio need not be slavish or

mechanistic and can be a powerful forcing device to move beyond generic
strategy statements, such as “strengthen in Asian markets” or “continue
to migrate from products to services.” Identifying business opportunities
where your company wants to increase its exposure can create
a foundation for scrutinizing how it allocates capital, talent, and
other resources.

Setting targets is just a starting point; companies also need mechanisms

for revisiting and adjusting them over time. For example, Google holds
a quarterly review process that examines the performance of all core
product and engineering areas against three measures: what each area did
in the previous 90 days and forecasts for the next 90 days, its medium-
term financial trajectory, and its strategic positioning. And the company

64 Role of the CFO: Selected readings for finance leaders

 8

has ensured that it can allocate resources in an agile way by not

having business units, which diminishes the impact of corporate politics.4

Evaluating reallocation performance relative to peers also can help com-

panies set targets. From 1990 to 2009, for example, Honeywell
reallocated about 25 percent of its capital as it shifted away from some
existing business areas toward aerospace, air conditioning, and controls
(for more on Honeywell’s approach to resource allocation, see our
interview with Andreas C. Kramvis, president and CEO of Honeywell
Performance Materials and Technologies, in “Breaking strategic
inertia: Tips from two leaders,” on mckinseyquarterly.com). Honeywell’s
competitor Danaher, which was in similar businesses in 1990,
moved 66 percent of its capital into new ones during the same period.
Both companies achieved returns above the industry average in these
years—TRS for Honeywell was 14 percent and for Danaher 25 percent.
We’re not suggesting that companies adopt a mind-set of “more is
better, and if my competitor is making big moves, I should too.” But
differences in allocation levels among peer companies can serve
as valuable clues about contrasting business approaches—clues that
prompt questions yielding strategic insights.

2. Use all available resource reallocation tools.

Talking about resource allocation in broad terms oversimplifies the
choices facing senior executives. In reality, allocation comprises
four fundamental activities: seeding, nurturing, pruning, and harvesting.
Seeding is entering new business areas, whether through an acquisi-
tion or an organic start-up investment. Nurturing involves building up
an existing business through follow-on investments, including bolt-on
acquisitions. Pruning takes resources away from an existing business,
either by giving some of its annual capital allocation to others or by
putting a portion of the business up for sale. Finally, harvesting is selling
whole businesses that no longer fit a company’s portfolio or under-
taking equity spin-offs.

Our research found that there’s little overall difference between the
seeding and harvesting behavior of low and high reallocators. This should
come as little surprise: seeding involves giving money to new business
opportunities—something that’s rarely resisted. And while harvesting
is difficult, it most often occurs as a result of a business unit’s sus-
tained underperformance, which is difficult to ignore.

4 For more, see James Manyika, “Google’s CFO on growth, capital structure, and leadership,”

mckinseyquarterly.com, August 2011.

65 Role of the CFO: Selected readings for finance leaders

9

However, we found a 170 percent difference in activity levels between

high and low reallocators when it came to the combination of nurturing
and pruning existing businesses. Together, these two represent half of
all corporate reallocation activity. Both are difficult because they often
involve taking resources from one business unit and giving them to
another. What’s more, the better a company is at encouraging seeding,
the more important nurturing and pruning become—nurturing to
ensure the success of new initiatives and pruning to eliminate flowers
that won’t ever bloom.

Consider, for example, the efforts of Google CEO Larry Page, over the
past 12 months, to cope with the flowering of ideas brought forth by
the company’s well-known “20 percent rule,” which allows engineers
to spend at least one-fifth of their time on personal projects and has
resulted in products such as AdSense, Gmail, and Google News. These
successes notwithstanding, the 20 percent rule also has yielded many
peripheral projects, which Page has recently been pruning.5

3. Adopt simple rules to break the status quo.

Simple decision rules can help minimize political infighting because
they change the burden of proof from the typical default allocation
(“what we did last year”) to one that makes it impossible to maintain the
status quo. For example, a simple harvesting rule might involve put-
ting a certain percentage of an organization’s portfolio up for sale each
year to maintain vibrancy and to cull dead wood.

When Lee Raymond was CEO of Exxon Mobil, he required the

corporate-planning team to identify 3 to 5 percent of the company’s
assets for potential disposal every year. Exxon Mobil’s divisions
were allowed to retain assets placed in this group only if they could
demonstrate a tangible and compelling turnaround program. In
essence, the burden on the business units was to prove that an asset
should be retained, rather than the other way around. The net effect
was accelerated portfolio upgrading and healthy turnover in the face
of executives’ natural desire to hang on to underperforming assets.
Another approach we’ve observed involves placing existing businesses
into different categories—such as “grow,” “maintain,” and “dispose”—
and then following clearly differentiated resource-investment rules for
each. The purpose of having clear investment rules for each category
of business is to remove as much politics as possible from the resource
allocation process.

5 See Claire Cain Miller, “In a quest for focus, Google purges small projects,” nytimes.com,

November 10, 2011.

66 Role of the CFO: Selected readings for finance leaders

 10

Sometimes, the CEO may want a way to shift resources directly, in

parallel with regular corporate processes. One natural-resources
company, for example, gave its CEO sole discretion to allocate 5 percent
of the company’s capital outside of the traditional bottom-up annual
capital allocation process. This provided an opportunity to move the
organization more quickly toward what the CEO believed were
exciting growth opportunities, without first having to go through a
“pruning” fight with the company’s executive-leadership committee.

Of course, the CEO and other senior leaders will need to reinforce
discipline around such simple allocation rules; it’s not easy to hold the
line in the face of special pleading from less-favored businesses.
Developing that level of clarity—not to mention the courage to fight
tough battles that arise as a result—often requires support in the
form of a strong corporate center or a strategic-planning group that’s
independent of competing business interests and can provide objec-
tive information (for more on the importance of the corporate center
to resource reallocation, see “The power of an independent corporate
center,” on mckinseyquarterly.com).

4. Implement processes to mitigate inertia.

Systematic processes can strengthen allocation activities. One approach,
explored in detail by our colleagues Sven Smit and Patrick Viguerie, is
to create planning and management processes that generate a granular
view of product and market opportunities.6 The overwhelming ten-
dency is for corporate leaders to allocate resources at a level that is too
high—namely, by division or business unit. When senior management
doesn’t have a granular view, division leaders can use their information
advantage to average out allocations within their domains.

Another approach is to revisit a company’s businesses periodically and

engage in a process similar to the due diligence conducted for invest-
ments. Executives at one energy conglomerate annually ask whether
they would choose to invest in a business if they didn’t already own
it. If the answer is no, a discussion about whether and how to exit the
business begins.

Executives can further strengthen allocation decisions by creating

objectivity through re-anchoring—that is, giving the allocation an objec-
tive basis that is independent of both the numbers the business units

6 See three publications by Mehrdad Baghai, Sven Smit, and S. Patrick Viguerie: “The

granularity of growth,” mckinseyquarterly.com, May 2007; The Granularity of Growth: How

to Identify the Sources of Growth and Drive Enduring Company Performance, Hoboken,
NJ: Wiley, 2008; and “Is your growth strategy flying blind?,” Harvard Business Review, May
2009, Volume 87, Number 5, pp. 86–97.

67 Role of the CFO: Selected readings for finance leaders

11

provide and the previous year’s allocation. There are numerous ways to
create such independent, fact-based anchors, including deriving
targets from market growth and market share data or leveraging
bench-
marking analysis of competitors. The goal is to create an objective way
to ask business leaders this tough question: “If we were to triangulate
between these different approaches, we would expect your investments
and returns to lie within the following range. Why are your estimates
so much higher (or lower)?”

Finally, it’s worth noting that technology is enabling strategy process

innovations that stir the pot through internal discussions and
“crowdsourcing.” For example, Rite-Solutions, a Rhode Island–based
company that builds advanced software for the US Navy, defense
contractors, and first responders, derives 20 percent of its revenue from
businesses identified through a “stock exchange” where employees
can propose and invest in new ideas (for more on this, see “The social
side of strategy,” forthcoming on mckinseyquarterly.com).

Much of our advice for overcoming inertia within multibusiness

companies assumes that a corporation’s interests are not the same as
the cumulative resource demands of the underlying divisions and
businesses. As they say, turkeys do not vote for Christmas. Putting in
place some combination of the targets, rules, and processes proposed
here may require rethinking the role and inner workings of a company’s
strategic- and financial-planning teams. Although we recognize that
this is not a trivial endeavor, the rewards make the effort worthwhile. A
primary performance imperative for corporate-level executives should
be to escape the tyranny of inertia and create more dynamic portfolios.

The authors would like to acknowledge the contributions of Michael

Birshan, Marja Engel, Mladen Fruk, John Horn, Conor Kehoe, Devesh
Mittal, Olivier Sibony, and Sven Smit to this article.

Stephen Hall is a director in McKinsey’s London office, and Reinier

Musters is an associate principal in the Amsterdam office. Dan Lovallo is
a professor at the University of Sydney Business School, a senior research
fellow at the Institute for Business Innovation at the University of California,
Berkeley, and an adviser to McKinsey.

68 Role of the CFO: Selected readings for finance leaders

A U G U S T 2 012

c o r p o r a t e f i n a n c e p r a c t i c e

Overcoming a bias
against risk
Risk-averse midlevel managers making routine investment decisions can shift an
entire company’s risk profile. An organization-wide stance toward risk can help.

Tim Koller, Here’s a quick test of your risk appetite. Your
Dan Lovallo, and investment team has approached you with two
Zane Williams variations of the same project: you can either
invest $20 million with an expected return of
$30 million over three years or you can invest
$40 million with an expected return of $100 million
over five years (and a bigger dip in earnings in
the early years). In each case, the likelihood that
the project will fail and yield nothing is the
same. Which would you choose?
Much of the commentary about behavioral
economics and its applications to managerial
practice, including our own, warns against
overconfidence—that biases in human behavior
might lead managers to overstate the likelihood of
a project’s success and minimize its downside.1
Such biases were certainly much debated during
the financial crisis.
Often overlooked are the countervailing behavioral
forces—amplified by the way companies struc-
ture their reward systems—that lead managers to
become risk averse or unwilling to tolerate
uncertainty even when a project’s potential earnings
are far larger than its potential losses.2 In fact,
the scenario above is based on the experience of a
senior executive in a global high-tech company
who ultimately chose the smaller investment with
the lower up-front cost. That variation of the

69 Role of the CFO: Selected readings for finance leaders


project would allow him to meet his earnings
goals, and even though the amount of additional
risk in the second variation was small—and
more than offset by a fivefold increase in the net
present value—it still outweighed the potential
rewards to him.
For projects of this size at a large company,
the profit forgone by choosing a safer alternative—
putting less money at risk with a shorter time to
payoff—is modest: in this case, about $20 million.
But the scenario becomes more worrying
when you consider that dynamics like this play out
many times per year across companies, where
decisions are driven by the risk appetite of individual
executives rather than of the company as a
whole. In a single large company making hundreds
of such decisions annually, the opportunity
cost would be $2 billion if this were to happen even
20 times a year over five years. Variations of this
scenario, played out in companies across the
world, would result in underinvestment that would
ultimately hurt corporate performance, share-
holder returns, and the economy as a whole.
Mitigating risk aversion requires that companies
rethink activities associated with investment
projects that cause or exacerbate the bias, from the
processes they use to identify and evaluate
projects to the structural incentives and rewards
they use to compensate managers.
A widespread challenge
The right level of risk aversion depends on the
size of the investment. CEOs making decisions
about large, unique investments are typically
more risk averse than overconfident—and they
should be, since failure would cause financial
distress for the company.
70 Role of the CFO: Selected readings for finance leaders
2
In contrast, midlevel executives making repeated
decisions about the many smaller investments
that a company might make during the course of a
year—expanding a sales force at a consumer-
goods company into a new geography, for example,
or introducing a product-line extension at an
electronics firm—should be risk neutral. That is,
they should not overweight negative or positive
outcomes relative to their actual likelihood of
occurrence. Decisions about projects of this size
don’t carry the risk of causing financial distress—
and aversion to risk at this level stifles growth and
innovation. Risk aversion is also unnecessary
because statistically, a large number of projects are
extremely unlikely all to fail (unless they are
highly correlated to the same risks). Yet many
managers at this level—who make many such
investments over a career—exhibit an unwarranted
aversion to risk.
In fact, we frequently run across CEOs stymied by
their company’s struggle with risk; decisions
that may be in the best interest of individual execu-
tives, minimizing the risk of failure, are actually
harmful for their companies. As the CEO at a
manufacturing company observed, his company’s
business unit–level leaders gravitate toward
relatively safe, straightforward strategies with
earnings goals that seem reachable, even if
these strategies mean slower growth and lower
investment along the way. We have also heard
from many nonexecutive board members that their
companies are not taking enough risks.
Their anecdotal observations are consistent
with findings we reported last year that suggested
executives are as risk averse about small invest-
ments as they are about large ones.3 When we tested
how 1,500 executives from 90 countries reacted
to different investment scenarios, we discovered
3
that they demonstrated extreme levels of risk
aversion regardless of the size of the investment,
even when the expected value of a proposed
project was strongly positive. Specifically, when
presented with a hypothetical investment
scenario for which the expected net present value
would be positive even at a risk of loss of 75 per-
cent, most respondents were unwilling to accept it
on those terms. Instead, they were only willing
to accept a risk of loss from 1 to 20 percent—and
responses varied little, even when the size
of the investment was smaller by a factor of ten.
This is almost shocking, as it suggests that
the level of risk aversion is remarkably constant
within organizations, when it should vary
based on the size of the investment and its
potential to cause financial distress.
Understanding the source of risk aversion
Much of the typical risk aversion related to
smaller investments can be attributed to a combi-
nation of two well-documented behavioral
biases. The first is loss aversion, a phenomenon in
which people fear losses more than they value
equivalent gains. The second is narrow framing,
in which people weigh potential risks as if
there were only a single potential outcome—akin
to flipping a coin only once—instead of viewing
them as part of a larger portfolio of outcomes—akin
to flipping, say, 50 coins. Together, these two
biases lead to a distinctive set of preferences out-
lined in Daniel Kahneman and Amos Tversky’s
prospect theory, which was largely the basis for
Kahneman’s 2002 Nobel Prize in Economics. 4
Consider a simple example of a risk-averse
manager5 weighing whether to invest $50 million
today in a project that has an equal likelihood
of returning either $100 million or $0 a year from
now. If we were to ignore the time value of
71 Role of the CFO: Selected readings for finance leaders
money, we would expect a risk-neutral manager
to be indifferent to the project—because the
potential gains are equal to the potential losses.
If the upside were greater than $100 million,
we would expect the same manager to make the
investment. However, the upside would have
to be almost $170 million to entice the typical risk-
averse manager to make the investment. In
other words, the upside would have to be about
70 percent larger in order for that manager
to overcome his or her aversion to risk.
But what if we were to pool these risks across
multiple projects? If the same manager faced not
one decision but ten, the story would change. The
manager’s range of outcomes would no longer be
an all-or-nothing matter of success or failure,
but instead a matter of various combinations of
outcomes—some more successful, some less.
In this case, the same manager would be willing
to invest if the upside were only $103 million,
or only 2 to 3 percent above the risk-neutral point.
In other words, pooling risks leads to a striking
reduction in risk aversion.
Many of the managerial tactics used by companies
in their capital-allocation and evaluation
processes fail to take note of these basic behaviors.
By considering the success or failure of projects
in isolation, for example, they fail to understand
how each will add risk to the company’s overall
portfolio and institutionalize a tendency toward
risk aversion, essentially recreating the narrow
framing that occurs at the individual level.
To make matters worse, many companies also
hold individuals responsible for the out-
comes of single projects that have substantial
uncertainty and fail to distinguish between
“controllable” and “uncontrollable” events, leaving
people accountable for outcomes they cannot

influence. As a result, many companies wind up
with risk aversion at the corporate level that
resembles that at the individual level—squandering
the risk-bearing advantages of size and risk
pooling that should be one of their greatest stra-
tegic advantages. In fact, many companies
seem to exacerbate loss aversion, which is the
primary driver of risk aversion.
Toward a company-wide approach to risk
Companies can reduce the effects of risk aversion,
where appropriate, by promoting an organization-
wide attitude toward risk that guides individual
executive decisions. More specifically, companies
should explore the following:
Up the ante on risky projects. Risk-averse
organizations often discard attractive projects
before anyone formally proposes them.
To encourage managers and senior executives to
explore innovative ideas beyond their comfort
levels, senior executives might regularly ask them
for project ideas that are risky but have high
potential returns. They could then encourage
further work on these ideas before formally
reviewing them. They could also require managers
to submit each investment recommendation
with a riskier version of the same project with
more upside or an alternative one.
Consider both the upside and downside.
Executives should require that project plans include
a range of scenarios or outcomes that include
both failure and dramatic success. Doing so will
enable project evaluators to better understand
their potential value and their sources of risk.
These scenarios should not simply be the baseline
scenario plus or minus an arbitrary percentage.
Instead, they should be linked to real business
72 Role of the CFO: Selected readings for finance leaders
4
drivers such as penetration rates, prices, and
production costs. For example, when evaluating
the introduction of a new consumer-goods
product, managers should explicitly consider what
a “home run” scenario would look like—one
with high market share or high realized unit prices.
They should also look at a scenario or two that
captures the typical experience of product intro-
ductions, as well as one scenario where it flops.
By forcing this analysis, executives can ensure that
the likelihood of a home run is factored into the
analysis when the project is evaluated—and they
are better able to thoughtfully reshape projects to
capture the upside and avoid the downside.
Avoid overcompensating for risk. Managers
should also pay attention to the discount rates
they use to evaluate projects. We repeatedly
encounter planners who errantly use a higher
discount rate simply because an outcome
is more uncertain or the range of possible out-
comes is wider (see “Avoiding a risk premium
that unnecessarily kills your project,” on
mckinseyquarterly.com). Higher discount rates for
relatively small but frequent investments, even
if they are individually riskier, do not make sense
once projects are pooled at a company level.
Instead, if companies are concerned about risk
exposure, they might adopt a rule that any
investment amounting to less than 5 to 10 percent
of the company’s total investment budget
must be made in a risk-neutral manner—with
no adjustment to the discount rate.
Evaluate performance based on portfolios of
outcomes, not single projects. Wherever possible,
managers should be evaluated based on
the performance of a portfolio of outcomes, not
punished for pursuing more risky individual
5

projects. In oil and gas exploration, for example,
executive rewards are not based on the per-
formance of individual wells but rather on a fairly
large number of them—as many as 20, in one
company. Hence, it may not be surprising to find
that oil and gas executives pool risks and are
more risk neutral.
Reward skill, not luck. Companies need to better
understand whether the causes of particular
successes and failures were controllable or uncon-
trollable and eliminate the role of luck, good or
bad, in structuring rewards for project managers.
They should be willing to reward those who
execute projects well, even if they fail due to antici-
pated factors outside their control, and also to
discipline those who manage projects poorly, even
if they succeed due to luck. Although not always
easy to do, such an approach is worth the effort.
The corporate center must play an active role in
implementing such changes—in setting policy,
facilitating risk taking, and serving as a resource
to help pool project outcomes. It will need
to become an enabler of risk taking, a philosophy
quite different from that currently expressed
by many corporate centers. The office of the CFO
should also be involved in oversight, since it
is particularly well suited to serve as manager of a
company’s portfolio of risks, making trade-
offs between them and taking a broader view of
projects and the effects of risk pooling.
1 Daniel Kahneman and Dan Lovallo, “Delusions of success:
How optimism undermines executives’ decisions,” Harvard
Business Review, July 2003, Volume 81, Number 7, pp. 56–63.
2 Daniel Kahneman and Dan Lovallo, “Timid choices and bold
forecasts: A cognitive perspective on risk taking,” Management
Science, 1993, Volume 39, Number 1, pp. 17–31.
3 Tim Koller, Dan Lovallo, and Zane Williams, “A bias against
investment?,” mckinseyquarterly.com, September 2011.
4 Daniel Kahneman and Amos Tversky, “Prospect theory: An

analysis of decision under risk,” Econometrica, 1979, Volume 47,

Number 2, pp. 263–91.
5 That is, a manager with a standard concave utility curve of the

type U(x) = x.575 in the domain of gains.

Tim Koller (Tim_Koller@McKinsey.com) is a partner in McKinsey’s New York office, where Zane Williams
(Zane_Williams@McKinsey.com) is a senior expert. Dan Lovallo is a professor at the University of Sydney Business
School, a senior research fellow at the Institute for Business Innovation at the University of California, and an
adviser to McKinsey. Copyright © 2012 McKinsey & Company. All rights reserved.

73 Role of the CFO: Selected readings for finance leaders

2

Zero-based budgeting: Five myths

and realities
Shaun Callaghan, Kyle Hawke, Greg Kelly, and Carey Mignerey

Companies often shy away from zero-based budgeting due to fear, doubt, or a belief that
it’s nothing more than ‘budgeting from zero.’ We dispel five common myths about the
process so that organizations might use it to realize significant, sustainable savings and
build a culture of cost management.

As many companies watch their sales, general, and administrative (SG&A) costs outstrip
revenues, controlling costs has become an even greater point of focus for shareholders and
analysts. As a result, executives are under ever-increasing pressure to deliver productivity
on an ongoing basis. Cost management is not just a topic for large, legacy companies—it is
equally relevant for fast-growing companies. Almost all companies have previously undertaken
productivity efforts in either traditional programs like outsourcing, offshoring, and strategic
sourcing, or in other one-off cost-reduction events. But in many cases, these efforts are still
not enough. Executives need bigger savings that can be sustained over time.

Unfortunately, the typical approach to identifying cost-reduction opportunities—examining

operating expenses in the aggregate—is poorly suited to driving realizable, lasting, and
significant benefits. The findings are often too high level to link clearly to the actions required
to unlock the savings. Moreover, managers can avoid action by refuting the underlying data or
citing unique business needs. Given such constraints, when savings are required, executives
often feel they have no choice but to slash and burn, making arbitrary budget cuts without
any changes to the underlying work, regardless of how prudent or sustainable those choices
may be.

Fortunately, there is a sustainable alternative to cost management appropriate for many

companies: zero-based budgeting (ZBB). We have heard of many versions of ZBB, including
the literal interpretation of the words: “a technique for building a budget from zero.” While that
is certainly a fundamental part of ZBB, our experience has shown that effective ZBB is much
more than that.

Zero-based budgeting is a repeatable process that organizations use to rigorously review

every dollar in the annual budget, manage financial performance on a monthly basis, and build
a culture of cost management among all employees. A world-class ZBB process is based
on developing deep visibility into cost drivers and using that visibility to set aggressive yet
credible budget targets. The annual budgeting process does in fact start from zero and is very
detailed, structured, and interactive in order to facilitate meaningful financial debate among
managers and executives. Throughout the year, multiple owners are tasked with managing
performance and continuing the healthy debate on cost management. Through new system

74 Role of the CFO: Selected readings for finance leaders

Zero-based budgeting:
Five myths and realities 3

and process controls, and aligned incentive programs, all employees make cost management
part of their daily routine.

One company recently realized 11 percent savings in its operating budget within the first four
months of a new ZBB program. In this instance, immediate savings came from increasing
visibility into labor costs and executing new approval thresholds to control demand for contract
labor, relaunching procurement initiatives to renegotiate prices, and changing “make versus
buy” decisions. More than 40 percent of the savings were strategically reinvested in new teams
and sales staff who spent all their time with customers. While this company chose to reinvest
those savings in the customer-facing parts of the business, other companies use the savings to
fund and therefore amplify the next wave of productivity. And, of course, some let the savings
fall to the bottom line.

When properly implemented, ZBB can reduce SG&A

“Zero-based budgeting is
much more than building a
budget from zero. World-class
ZBB efforts successfully build
cultures of cost management
throughout the organization ...”
costs by 10 to 25 percent, often within as little as six
months. Just how ZBB is capable of delivering and sus-
taining these results remains a bit of a mystery for many
executives. The opaqueness of the term and the dire tone
of the media stories can be intimidating, sometimes caus-
ing it to be taken off the table as an option for improving
productivity. What follows is an attempt to explore some
common myths, debunking them and highlighting how
a well-run ZBB program can drive sustainable impact in
leading organizations.

Myth one: ZBB simply means building your budget from zero
Reality: ZBB is a repeatable process to build a sustainable culture of cost management.

Zero-based budgeting is much more than building a budget from zero. World-class ZBB
efforts successfully build cultures of cost management throughout the organization by using a
structured approach to facilitate cost visibility, cost governance, cost accountability, and aligned
incentives. Fortunately the culture shift isn’t left to chance. We believe that there is a proven,
step-by-step approach to implementing successful ZBB programs, and when this implementa-
tion is done well, ZBB makes cost management a part of the way every employee works on a
daily basis.

75 Role of the CFO: Selected readings for finance leaders

4

Myth two: Implementing ZBB requires cutting ‘to the bone’

Reality: The degree of cost reduction is based on the company’s top-down target.

Although very little has been written recently about zero-based budgeting, the published
content that exists often associates it with cutting costs to the bone, using any means
necessary (for example, eliminating mini refrigerators in office kitchens to save electricity).
While this may sometimes occur, it is by no means necessary. Simply put, the degree (and
aggressiveness) of each company’s cost cutting reflects the size of its top-down savings
target. For instance, in the most aggressive situations, we’ve seen 30 percent reduction
targets in year one versus other situations that aim for 10 percent reduction targets with
an agreement to reinvest half of that into more productive areas, therefore only taking 5
percent to the bottom line.

Myth three: ZBB will overwhelm your business and prevent it

from doing anything else
Reality: Initial rollout of a new ZBB program can be led by a central team and completed
in four to ten months.

Recently, one executive we met with said, “I simply cannot afford to ask the entire company
to stop what they’re doing for the year to implement ZBB.” The idea that ZBB requires
dedicated focus from every employee for a year or more is simply not true. While it takes
time to embed a new cost-management culture into any organization, the setup and rollout
of a new ZBB program has much more limited requirements.

During the initial setup, a central coordination team develops deep visibility into costs and
sets detailed savings targets for the next budgeting cycle. That team also ensures that the
company’s systems and processes are in place for the detailed reporting, governance, and
performance management that a world-class ZBB requires. In our experience, this setup
period could take anywhere from four to ten months and is primarily led by full-time support
from finance and IT, with part-time involvement from profit-and-loss owners and cost-
category owners across the company.

Organizations that are unsure about ZBB’s upside are

well suited to pilot the process. There are many ways “The idea that ZBB
to build these pilots, each of which can be customized
to meet the company’s objectives. One company, for requires dedicated focus
instance, is piloting a ZBB rollout across its global
finance function. This approach builds capabilities
from every employee for
within the team that will help drive the program a year or more is simply
across the enterprise while having the added
benefit of helping team members achieve their not true. “
existing budget targets.

76 Role of the CFO: Selected readings for finance leaders

Zero-based budgeting:
Five myths and realities 5

Myth four: ZBB only focuses on SG&A

Reality: ZBB can be applied to any type of cost: capital expenditures, operating expenses,
sales, general, and administrative costs, marketing costs, variable distribution, or cost of
goods sold.

The fundamental elements of a ZBB program—governance, accountability, visibility, aligned

incentives, and a rigorous process—form a comprehensive cost-management tool kit.
However, certain adjustments need to be made when using this tool kit in particular areas.
For example, when ZBB is applied to variable costs (for example, cost of goods sold, variable
distribution) the budget needs to be volume adjusted in monthly performance reports. When
ZBB is applied to capital expenditures, costs are categorized by discrete investment choices
rather than types of expenses, as they are with operating expenses.

Myth five: ZBB is not designed for growth-oriented companies

Reality: ZBB is successfully used by growing companies to redirect unproductive costs to
more productive areas that drive growth.

Zero-based budgeting is a Zero-based budgeting is a powerful tool for any

powerful tool for any company,
whatever its orientation. Even if
the organization’s primary focus
is on growth, profit, or talent
retention, cost management
remains crucial to its success.
company, whatever its orientation. Even if the organi-
zation’s primary focus is on growth, profit, or talent
retention, cost management remains crucial to its
success. Eliminating unproductive costs allows the
company to be redirected to more productive areas.
As we mentioned in the earlier example, back-office
costs can be redirected to customer-facing activities.
ZBB is not a slash-and-burn exercise that cuts costs
without regard for the expense. With deep visibility into
costs, changes can be made to surgically cut the fat
and help build up organizational muscle.

Conclusion
In summary, zero-based budgeting can drive significant and sustainable savings, but it is
much more than simply building a budget from zero. World-class ZBB programs build a
culture of cost management through unprecedented cost visibility, a unique governance
model, accountability at all levels of the organization, aligned incentives, and a rigorous and
routine process. ZBB frees up unproductive costs and allows those savings to be taken to the
bottom line or redirected to more productive areas that will drive future growth.

Shaun Callaghan is a consultant in McKinsey’s New Jersey office, and Kyle Hawke is a
consultant in the Atlanta office, where Greg Kelly is a director and Carey Mignerey is an
associate principal.

Copyright © McKinsey & Company

www.mckinsey.com/section/function 77 Role of the CFO: Selected readings for finance leaders
 © Dave and Les Jacobs/Blend Images/Getty Images

The return of zero-base

budgeting
The venerable technique has vaulted back into the consciousness of corporate leaders—for good reason.
But getting it right is not easy and depends on five key elements.

Matt Fitzpatrick and Kyle Hawke

“Zero-base budgeting” (ZBB) was first introduced
to the public in a 1970 article by Peter A. Pyhrr
in the Harvard Business Review1 and soon gained
a following. However, over the last half century,
the tool became dogged by misperceptions and faded
into obscurity.2 Today, it is enjoying a renaissance.
The number of companies publicly referring to zero-
base budgeting has exploded over the past few
years, including such disparate companies as Alcoa,
Boston Scientific, Jarden Corporation, and
Quiksilver (exhibit). It’s not only big companies that
have taken to ZBB; businesses of all sizes are taking
the leap. For example, B&G Foods—a US-based
multibrand company with $850 million in annual
sales and less than $100 million in sales, general,
and administrative (SG&A) expenses—has recently
adopted ZBB. It’s becoming clear that ZBB can be
effective across industries, in companies big and
small, and under both public and private ownership.
ZBB of the 1970s was fundamentally about ascribing
each company activity to a decision “package,”
evaluating and ranking these packages for their
costs and benefits, and allocating resources
accordingly.3 Today’s ZBB is much more than
that—it’s a repeatable process to rigorously review
every dollar in the annual budget, manage monthly
financial performance, and build a culture of cost
management. What makes ZBB unique is not the
budgeting methodology; it is the mind-set shift that
upends managers’ default assumptions. Rather
than compare this year’s spending to last year’s,

The return of zero-base budgeting 78 Role of the CFO: Selected readings for finance leaders
7
 Exhibit 1 of 1
Exhibit Zero-base budgeting is back.
Number of companies mentioning zero-base
budgeting on quarterly earnings calls
90
62
14
2013 2014 20151
1 Projected based on year-to-date mentions.
Source: Seeking Alpha; McKinsey analysis
ZBB looks instead for the most-efficient return on
spending, from the bottom up. As one executive who
recently made the transition to ZBB told us, “It was
more effective to talk about every dollar spent in
terms of efficiency, and ask if it was really necessary,
rather than to compare it to last year. It resets
the discussion.”
ZBB is especially useful for private-equity firms. It
aligns well with the return-on-capital approach that
the industry favors. It can eliminate unproductive
costs (often as much as 10 to 25 percent of SG&A in
six months), allowing owners to reallocate capital
to growth, through marketing, sales, and M&A. And
ZBB is a standardized and replicable playbook that
can be rolled out across a portfolio of companies,
ensuring aligned processes, controls, cadences, and
incentives. For private-equity operating groups
seeking standardization (with a helpful degree of
flexibility), ZBB is the perfect fit.
8 McKinsey on Investing Number 2, Summer 2015
79
Five factors of success
Some executives ask us whether zero-base budgeting
is the “secret sauce” for cost reduction. It is an
important tool, but just as important are the orga-
nizational elements that must support it, such as
management buy-in, the organization’s willingness
to challenge current thinking, and its tolerance
of the risks that arise when making changes to reduce
costs. In our experience, the following five factors
are required to build the culture of cost man-
agement that distinguishes superior ZBB from
mediocre efforts:
ƒ Deeper visibility into cost drivers. Companies
need a granular understanding of the drivers
of costs so that managers can make better and
quicker decisions on how to control them.
Tactically, that means grouping costs into a matrix
with two dimensions—the type of expense and
the owner—to make the drivers clearer. Without
this visibility, it’s too easy to explain away “the
way things are” and why they cannot change.
ƒ Dual-ownership governance model. Two people,
the P&L owner and a leader from a functional
cost center (such as IT), should focus on driving
down the expenses in a given “package.” The
addition of a second owner takes away autonomy
from the P&L owner and results in an ongoing
and healthy dialogue on cost management. This
governance model helps spread best practices
across business units and geographies. It also
ensures that windfalls in one area do not
get subconsciously reallocated somewhere else.
That’s the problem at the root of something we
often hear CFOs say: “I don’t understand—on
paper we saved $100 million, but my EBIT is flat.”
ƒ Rigorous processes for planning and monitoring.
Budgeting from zero is just one part of the
planning process. Others include the setting of
aggressive top-down targets by the C-suite
(supported by detailed bottom-up analysis) and
Role of the CFO: Selected readings for finance leaders
Zero-base budgeting is an effective tool, and it is also
a thorough process that takes time to execute.
structured budget negotiations across the
company, with a common fact base and analogous
cost comparisons across operating units.
Monthly checkups on these plans ensure that
savings don’t slip away and unfavorable variances
are quickly addressed by both cost owners.
ƒ Aligned incentives. Adding an explicit metric
to measure cost performance (in addition to
growth and profit) aligns compensation to cost-
management objectives. Metrics should consider
only what is under each manager’s control, to
avoid penalizing managers in the field when, say,
intercompany charges and allocations from the
corporate center rise.
ƒ Mind-set. Perhaps the most critical change is in
managers’ mind-set. ZBB is most successful
when managers stop trying to prove why some-
thing is the way it is and start thinking actively
about ways to make it better, the same way they
do at home when the money is coming out of
their own wallet. This includes a shift to “arguing
things in” rather than “arguing things out,” and
the realization that no spending is too small to be
reviewed. One hundred small changes that save
$100,000 apiece still add up to $10 million.
A tool for all seasons
ZBB is an effective tool, but it is also a thorough
process that takes time to execute and requires
management buy-in. Before budgeting begins,
The return of zero-base budgeting
80
management needs to build a highly detailed fact
base, develop visibility into cost drivers, and
put in the effort needed to support aggressive top-
down targets with detailed bottom-up analysis.
Given the high degree of change required—the new
financial-planning process, modified incentives,
as well as the execution of significant cost reductions—
ZBB is most effective at companies with willing
and able management (often newly installed) and
a small and aligned investor group that has
control of the company. ZBB is less successful in
growth-capital investments.
More companies are taking up ZBB every month,
in every kind of circumstance. In our experience, the
following situations present an ideal time to begin
the transition in a portfolio company:
ƒ at the start of the first annual budget cycle under
private-equity ownership
ƒ at a change in management, with the
opportunity it presents to reset
the company’s behaviors and practices
ƒ when a company is underperforming and
the need to exit is rising
ƒ when a company’s performance culture
resists continuous improvement
ƒ when a company needs funding for
growth initiatives
9
Role of the CFO: Selected readings for finance leaders
 In a 2014 McKinsey survey of private-equity
operating groups, 4 firms agreed that a standardized
playbook across their companies is highly desirable.
While some firms have made some headway in
several core processes, budgeting is often more ad
hoc and company specific. ZBB gives private owners
the standard but flexible approach they want for
perhaps the most essential corporate process: the
allocation of capital.
It is thus no surprise that, 45 years after its
creation, ZBB is making a comeback. Private-equity
firms and others are finding it a useful frame-
work to reset a company’s default mode of operating
and drive sustainable cost efficiency. This time
around, ZBB seems likely to stick: the new incarna-
tion is more likely to become a widespread norm
than to fade into the ether. For ZBB 2.0, this may be
just the beginning.
10 McKinsey on Investing Number 2, Summer 2015
81 Role of the CFO: Selected readings for finance leaders
1 Peter A. Pyhrr, “Zero-base budgeting,” Harvard Business
Review, November/December 1970, Volume 48, Number 6,
pp. 111–21.
2 See Shaun Callaghan, Kyle Hawke, and Carey Mignerey,
“Five myths (and realities) about zero-based budgeting,” October
2014, mckinsey.com.
3 Pyhrr, “Zero-base budgeting.”
4 Andrew Mullin and Alex Panas, “Private-equity operations:
Inside the black box,” McKinsey on Investing, Winter 2014/15,
mckinsey.com.
Matt Fitzpatrick (Matt_Fitzpatrick@McKinsey.com) is
an associate principal in McKinsey’s New York office,
and Kyle Hawke (Kyle_Hawke@McKinsey.com) is a
consultant in the Atlanta office.
Copyright © 2015 McKinsey & Company.
All rights reserved.
Centered leadership

83 How centered leaders achieve extraordinary results

82 Role of the CFO: Selected readings for finance leaders

 Joanna Barsh, Josephine
Mogelof, and Caroline Webb

How centered
leaders achieve
extraordinary
results
Artwork by Gwenda Kaczor

Executives can thrive at

work and in life by adopting a
leadership model that
revolves around finding their
strengths and connecting
with others.

83 Role of the CFO: Selected readings for finance leaders

8888 78_91.indd 78 9/15/10 5:33 PM

 One senior manager’s harrowing moment
of truth, on page 89.

The problem
Today’s complex, volatile, and
fast-paced business environment
is placing extraordinary stress
on leaders.

Why it matters
Many leaders lack the skills needed
to cope, which undermines
organizational performance and
personal satisfaction.

What you should do about it

Cultivate the capabilities we have
identified in research on leaders
who can unlock the organization’s
potential in challenging
circumstances:

Give your life and work a sense

of meaning that you communicate
openly to others.

Frame challenges constructively,

emphasizing opportunities in
change and uncertainty.

Tap a broad constellation of

internal and external constituents
who can help your organization
succeed.

Engage proactively with risks

and help your organization do the
same.

Sustain your energy while

creating the conditions for others
to restore theirs.

84 Role of the CFO: Selected readings for finance leaders

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 80 2010 Number 4

For the past six years, we have been on a journey to learn from
leaders who are able to find the best in themselves and in turn inspire,
engage, and mobilize others, even in the most demanding circum-
stances. And the business environment has become more demanding:
the global financial crisis and subsequent economic downturn have
ratcheted up the pressure on leaders already grappling with a world in
transformation. More than half of the CEOs we and our colleagues
have spoken with in the past year have said that their organization must
fundamentally rethink its business model.

Our work can help. We have conducted interviews with more than
140 leaders; analysis of a wide range of academic research in fields as
diverse as organizational development, evolutionary biology, neuro-
science, positive psychology, and leadership; workshops with hundreds of
clients to test our ideas; and global surveys. Through this research, we
distilled a set of five capabilities that, in combination, generate high levels
of professional performance and life satisfaction. We described this
set of capabilities, which we call “centered leadership,” in the Quarterly in
2008 and subsequently in a book, How Remarkable Women Lead.1
Since then, through additional interviews and quantitative research, we’ve
continued to validate the model’s applicability to leaders across differ-
ent regions, cultures, and seniority levels. Better yet, we have confirmed
that centered leadership appears equally useful to men. In other words,
it is not just for women, but for all leaders in demanding circumstances.

Five capabilities are at the heart of centered leadership: finding

meaning in work, converting emotions such as fear or stress into oppor-
tunity, leveraging connections and community, acting in the face of
risk, and sustaining the energy that is the life force of change. A recent
McKinsey global survey of executives shows that leaders who have
mastered even one of these skills are twice as likely as those who have
mastered none to feel that they can lead through change; masters
of all five are more than four times as likely.2 Strikingly, leaders who have
mastered all five capabilities are also more than 20 times as likely to
say they are satisfied with their performance as leaders and their lives
in general.

For more on the research, see sidebar,

“The value of centered leadership,” on page 82.

1 Joanna Barsh, Susie Cranston, and Geoffrey Lewis, How Remarkable Women Lead: The

Breakthrough Model for Work and Life, New York: Crown Business Publishing, 2009.
2 The online survey was in the field from July 6 to 16, 2010. It garnered responses from

2,498 executives representing all regions, industries, functional specialties, and tenures.
Respondents indicated their level of agreement with statements representing various
dimensions of the leadership model. We then aggregated their answers into degrees of
mastery of each dimension.

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 How centered leaders achieve extraordinary results 81

exhibit
Five dimensions of centered leadership
Intelligence
Preconditions: Tolerance for change
Desire to lead
Communication skills

Managing
Meaning
energy
Happiness
Minimizing depletion
Signature strengths
Restoration
Purpose
Flow

Your
personal Impact:
and Presence
Engaging Positive
professional Resilience
Voice framing
Ownership
context Belonging
Self-awareness
Risk taking Learned optimism
Adaptability Moving on

Connecting
Network design
Sponsorship
Reciprocity
Inclusiveness

While such results help make the case for centered leadership, execu-
tives seeking to enhance their leadership performance and general satis-
faction often find personal stories more tangible. Accordingly, as this
article revisits the five dimensions of centered leadership—and their appli-
cability to times of uncertainty, stress, and change—we share the experi-
ences of four men and one woman, all current or former CEOs of major
global corporations.

Meaning

We all recognize leaders who infuse their life and work with a sense of
meaning. They convey energy and enthusiasm because the goal is impor-
tant to them personally, because they are actively enjoying its pursuit,
and because their work plays to their strengths. Our survey results show
that, of all the dimensions of centered leadership, meaning has a sig-
nificant impact on satisfaction with both work and life; indeed, its contri-
bution to general life satisfaction is five times more powerful than that
of any other dimension.

Whatever the source of meaning (and it can differ dramatically from one
person to another), centered leaders often talk about how their pur-
pose appeals to something greater than themselves and the importance of

(Continued on page 84)

86 Role of the CFO: Selected readings for finance leaders

 82 2010 Number 4

The value of centered leadership:

About the research

This article rests in part on the there were statistically significant

results of our latest survey on
centered leadership.1 We asked
more than 2,000 executives around
the world questions that allowed
us to assess their mastery of the five
dimensions of centered leadership
and how satisfied they are with their
professional leadership and their
lives overall.
We found that men and women
are very similar in the degree
to which they practice the elements
of centered leadership, and
experience satisfaction in their work
performance and their lives
(Exhibit 1). Further, among the 29
questions that we used to assess
mastery of each dimension,
differences between men and
women on only 11, and those
differences were minimal. (For our
purposes, respondents master
each dimension when their answers
put them in the top 20 percent of
overall scores.)
Women do have a slight edge:
they have a higher share of the top
quintile than of the overall pool,
suggesting that centered leadership
remains geared to women’s
strengths.2 That a very high share of
men have mastered each dimen-
sion shows, however, that centered
leadership is not about being
a woman but rather about abilities,
mind-sets, and behaviors

Q4 2010
Centered leadership
Exhibit
Exhibit11 of 2
Men and
Exhibit women
title: alike can
Elements master the
of centered dimensions of centered
leadership
leadership and feel successful in both their performance at work
and their lives.

Net scores,1 n = 2,177

Men Dimensions Outcomes

Women
4.01 Performance/ 4.14
Meaning
4.04 leadership 4.12

4.08 General 3.89

Framing
4.07 satisfaction 3.87

3.77
Connecting
3.83

4.07
Engaging
4.10

3.69
Energizing
3.76

1 All results are mean scores calculated on a 5-point scale, where 5 is equal to “strongly agree.”

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 How centered leaders achieve extraordinary results 83

sometimes considered feminine, have mastered any dimension

such as being motivated by
meaning at work—as opposed to
pay or status—and seeking to forge
community and collaboration.
The results also make it clear that
there is a tight relationship between
mastery of centered leadership
and the self-assessed performance
of executives as leaders and
their satisfaction with life in general.
1 For more, see “The value of centered
Notably, the more of the relevant
dimensions leaders master, the
2 Women made up 35 percent of the
likelier they are to be very satisfied
with their performance (Exhibit 2).
Finally, we observed that the
except connecting. This suggests
that young people seeking to
become leaders would benefit sig-
nificantly from undertaking the
centered-leadership journey sooner
rather than later. Further, companies
that support their young executives
in doing so will reap the benefits,
such as higher performance and
greater corporate resilience, earlier.
leadership: McKinsey Global Survey results,”
mckinseyquarterly.com, September 2010.
total sample; the shares of women who
have mastered the various dimensions range
from 34 to 41 percent, with four of the
five above 35 percent.

youngest respondents—both men

and women—were least likely to

Q4 2010
Centered leadership sidebar
Exhibit 2
Exhibit 2 of 2
The more of the relevant dimensions leaders master, the likelier
Exhibit title: The influence of dimensions
they are to be very satisfied with their performance.

% of respondents

Respondents with the highest average scores in each outcome

Performance/leadership1 General satisfaction2

Have mastered all of the

79 83
relevant dimensions

Have mastered none of

5 4
the relevant dimensions

1 For performance/leadership, the 4 dimensions that have a meaningful impact on outcome scores are, in order of descending
influence, meaning, engaging, framing, and connecting; for “mastered all,” n = 106; for “mastered none,” n = 1,302.
2For general satisfaction, the 4 dimensions that have a meaningful impact on outcome scores are, in order of descending influence,
meaning, energizing, engaging, and connecting; ; for “mastered all,” n = 103; for “mastered none,” n = 1,258.

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 84 2010 Number 4

conveying their passion to others (for more on conveying meaning to others,

see “Revealing your moment of truth,” on page 89). Time and again, we
heard that sharing meaning to inspire colleagues requires leaders to become
great storytellers, touching hearts as well as minds. These skills are
particularly applicable for executives leading through major transitions,
since it takes strong personal motivation to triumph over the discom-
fort and fear that accompany change and that can drown out formal
corporate messages, which in any event rarely fire the souls of employees
and inspire greater achievement.

Avon Products CEO Andrea Jung described how meaning and storytelling
came together when her company faltered after years of rapid growth.
Andrea’s personal challenge was acute because some key sources of
her passion—creating a bold vision for growth and inspiring others to
dream big, being a member of a close-knit community, and achieving
extraordinary results—were deeply connected with her work at Avon. Sud-
denly, it became harder for her to see where her momentum would
come from. What’s more, she had to streamline her cherished community.

To remain true to her personal values, Andrea rejected the “more efficient”
approach of delegating to managers the responsibility for communi-
cating with employees about the restructuring and of sharing information
only on a need-to-know basis. Instead, she traveled the world to offer
her teams a vision for restoring growth and to share the difficult decisions
that would be required to secure the company’s future. The result?
Employees felt that Andrea treated them with honesty and humanity, making
the harsh reality of job reductions easier to accept and giving them more
time to prepare. They also experienced her love for the company firsthand
and recognized that both she and Avon were doing all they could. By
instilling greater resilience throughout the organization, Avon rebuilt its
community and resumed growth within 18 months.

Positive framing

Positive psychologists have shown that some people tend to frame the
world optimistically, others pessimistically.3 Optimists often have an edge:
in our survey, three-quarters of the respondents who were particularly
good at positive framing thought they had the right skills to lead change,
while only 15 percent of those who weren’t thought so.

For leaders who don’t naturally see opportunity in change and uncertainty,
those conditions create stress. When faced with too much stress (each
of us has a different limit), the brain reacts with a modern version of the
“fight, flight, or freeze” instinct that saber-toothed tigers inspired in early

3 Martin E. P. Seligman, Authentic Happiness: Using the New Positive Psychology to Realize

Your Potential for Lasting Fulfillment, New York, NY: Free Press, 2004.

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 How centered leaders achieve extraordinary results 85

humans. This response equips us only for survival, not for coming up
with creative solutions. Worse yet, in organizations such behavior feeds
on itself, breeding fear and negativity that can spread and become the
cultural norm.

When Steve Sadove took over Clairol, in 1991, for example, the com-
pany had been shell-shocked by a significant decline in sales volume. “I
remember going to a very creative person, who did all the packaging
and creative development,” Steve told us, “and saying, ‘Why don’t we do
anything creative?’ He opened some drawers in his desk and started
showing me all of this wonderful work that he’d done. Nobody was asking
for it; people kept their head down in that culture. So part of my role
as the leader was to create an environment that was going to allow inno-
vation and creativity and make it OK to fail.”

Fortunately, we can all become aware of what triggers our fears and learn
to work through them to reframe what is happening more construc-
tively. Once we have mastered reframing, we can help others learn this
skill, seeding the conditions that result in a safe environment where
all employees are inspired to give their best.4

Steve found ways to stimulate creativity, such as exploring opposing points

of view in discussions with colleagues. Over time, he convinced others
that speaking up wasn’t just tolerated but encouraged. He helped colleagues
reframe the way they reacted to dissent, forging a less defensive and
ultimately more innovative culture. Steve and his team introduced a win-
ning hair care brand, Herbal Essences, and ushered in a golden period
of growth for Clairol.

Connecting

With communications traveling at warp speed, simple hierarchical

cascades—from the CEO down until the chain breaks—are becoming less
and less effective for leaders. For starters, leaders depend increasingly
on their ability to manage complex webs of connections that aren’t suited
to traditional, linear communication styles. Further, leaders can find
the volume of communication in such networks overwhelming. While this
environment can be challenging, it also allows more people to contri-
bute, generating not only wisdom and a wealth of ideas but also immea-
surable commitment.

The upshot: CEOs have always needed to select exemplary leadership

teams. Increasingly, they must also be adept at building relationships with
people scattered across the ecosystem in which they do business and at
4 Michael A. Cohn et al., “Happiness unpacked: Positive emotions increase life satisfaction

by building resilience,” American Psychological Association, Emotion, 2009, Volume 9,

Number 3, pp. 361–68.

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 86 2010 Number 4

bringing together the right people to offer meaningful input and support
in solving problems.

Macy’s CEO Terry Lundgren learned firsthand about the power of

connecting the internal community in 1988 when, 15 months after joining
the retailer Neiman Marcus, he became its president and CEO. Shaking
things up was core to his role: “I was one of the first non–Marcus family
members with that title for any extended period of time.” Employees
greeted him with widespread skepticism. “They were all thinking, ‘Who is
this 37-year-old guy who is going to tell us how we should run our
fantastic business?’” So Terry held a town hall meeting in the library across
the street from company headquarters, in downtown Dallas. He invited
anybody who wanted to come. The first time, he recalls, “I had only about
30 people show up! I thought it was going to be a little bit bigger than
that, but I tried to be very direct and use the time mostly to listen and
respond.” He kept holding meetings, noting that “it really moved the
needle quickly in terms of getting things done in that company.” By the time
Terry left, the twice-a-year meetings filled a 1,200-seat auditorium.

Today, as Terry leads Macy’s, he connects the dots internally and

externally in many ways, from scheduling a monthly breakfast with new
managers to forming relationships with peers who have led companies
through change. Terry has also emphasized corporate connectivity,
regrouping Macy’s stores into 69 districts, each tasked with creating “My
Macy’s” for its customer base. And comparable-store sales are up this
year, reversing a negative trend. Terry’s top team believes its efforts to
connect managers more closely to one another and to customers,
through enhanced information sharing and product offerings tailored
to local needs, help explain the company’s trajectory.

Engaging

Of survey respondents who indicated they were poor at engaging—with

risk, with fear, and even with opportunity—only 13 percent thought
they had the skills to lead change. That’s hardly surprising: risk aversion
and fear run rampant during times of change. Leaders who are good
at acknowledging and countering these emotions can help their people
summon the courage to act and thus unleash tremendous potential.

But for many leaders, encouraging others to take risks is extremely difficult.
The responsibility CEOs feel for the performance of the entire organi-
zation can make the very notion of supporting risk taking extremely uncom-
fortable. What’s more, to acknowledge the existence of risk, CEOs must
admit they don’t, in fact, have all the answers—an unusual mind-set for
many leaders whose ascent has been built on a virtuous cycle of success
and self-confidence.

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 How centered leaders achieve extraordinary results 87

Doug Stern, CEO of United Media, has a number of ways to help his
people evaluate risks and build their confidence about confronting the
unknown. Because he has seen the destructive impact of anxiety,
Doug follows an explicit process anytime he’s facing a new, risky project
(for example, selling some of his company’s assets). The process helps
everyone—himself included—prepare by devising risk mitigation
strategies using these steps:

• asking the team to imagine every bad scenario, even the most remotely
possible—what he calls the “darkest nightmares”

• giving everyone a chance to describe those scenarios in detail and then to

“peer into the darkness” together

• devising a detailed plan for countering each nightmare—in effect,

rehearsing the best collective response to each potential issue

Once fears have surfaced and been dealt with, the team has a protocol in
place for every worst possible scenario and a set of next steps to implement.5

Managing energy

Sustaining change requires the enthusiasm and commitment of large

numbers of people across an organization for an extended period of time.
All too often, though, a change effort starts with a big bang of vision
statements and detailed initiatives, only to see energy peter out. The
opposite, when work escalates maniacally through a culture of “relentless
enthusiasm,” is equally problematic.6 Either way, leaders will find it
hard to sustain energy and commitment within the organization unless
they systemically restore their own energy (physical, mental, emotional,
and spiritual), as well as create the conditions and serve as role models for
others to do the same. Our research suggests sustaining and restoring
energy is something leaders often skimp on.

While stress is often related to work, sometimes simple bad luck is at play,
as Jurek Gruhn, president of Novo Nordisk US, can attest. Nine years
ago he was diagnosed with Type 1 diabetes. Working for a world leader in
diabetes care, Jurek was no stranger to the illness and, along with his
optimistic spirit, his no-nonsense orientation became a deep source of
energy: “My first reaction was, ‘You may have Type 1 diabetes, but you

5 Psychologist Gary Klein has developed and applied in a variety of settings a similar

approach that he calls the “premortem.” For more on this technique, and on the broader
problem of executive overconfidence, see “Strategic decisions: When can you trust
your gut?” mckinseyquarterly.com, March 2010.
6 Edy Greenblatt, Restore Yourself: The Antidote for Professional Exhaustion, Los Angeles,

CA: Execu-Care Press, 2009.

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 88 2010 Number 4

could also have a lot of other diseases that are much worse.’” So, he told us,
“I went to the hospital for two or three days of testing and then went
back home. We had our Christmas break. After that, I was back in the office.
My wife, who is a physician, said to me, ‘That was a quick process!’ I
basically took on my disease as a task.”

Jurek realized that one key to living a normal life with the disease is to
embrace life, at work and at home. “A healthy lifestyle is important. I have
five kids: my oldest daughter is 25, and my youngest is 6. Sometimes
they completely drain my energy, but they can energize me a lot. And now
I feel healthier because I have also changed my lifestyle: I eat breakfast
now every day, I exercise much more, and I started rock-climbing on a
regular basis.” Everything improved—his physical condition, mental
focus, emotional satisfaction, and spirit. He even learned to face what
drained him most—unhealthy conflict at work—by addressing it
directly and quickly, much as he handled his diabetes.

Even for leaders without such a challenge, Jurek sets another valuable
example: “I saw this comedian who said that a man’s brain is filled with
boxes, and one of them is empty. Well, when the day’s really tough in
the office, I go into my empty box for 10 or 15 minutes and I do nothing. If
I completely switch off for a short period of time, I get my energy back.
Now, I’m not switching off every 15 minutes after working for 15 minutes—
maybe I do it every few days. But I do not work weekends unless I
really have to. And I’m not one who wakes up and the first thing is the
BlackBerry. No way!”

Centered leadership is a journey, not a destination, and it starts with a

highly personal decision. We’ll leave you with the words of one executive
who recently chose to embark on this path: “Our senior team is always
talking about changing the organization, changing the mind-sets and
behavior of everyone. Now I see that transformation is not about that. It
starts with me and my willingness and ability to transform myself.
Only then will others transform.”

Joanna Barsh is a director in McKinsey’s New York office, Josephine

Mogelof is a consultant in the Los Angeles office, and Caroline Webb is a
principal in the London office.

Copyright © 2010 McKinsey & Company. All rights reserved.

We welcome your comments on this article. Please send them to
quarterly_comments@mckinsey.com.

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Expanding the CFO lens

95 Are you getting all you can from your board of directors?

102 M&A as competitive advantage

94 Role of the CFO: Selected readings for finance leaders

16 McKinsey on Finance Number 52, Autumn 2014
Are you getting all you can from
your board of directors?
Veteran director David Beatty finds many boards wanting—and considers how
to improve them.
Jonathan Bailey and Boards of directors have always, in all cultures,
Tim Koller represented the shareholders in publicly traded
companies—validating financial results, protecting
their assets, and counseling the CEO on strategy
and on finding, then nurturing, the next generation
of leaders. It’s a tough and demanding respon-
sibility, requiring individual directors to learn as
much as they can about a company and its
operations so that their insights and advice can
stand up alongside those of executives. That,
at least, is the ideal.
One litmus test of whether or not the ideal is
coming anywhere close to being the reality these
days is the growth and involvement of activist
investors. If boards were doing their jobs, there
95 Role of the CFO: Selected readings for finance leaders
would be no activist opportunities. That’s
according to David Beatty, Conway Chair of the
Clarkson Centre for Business Ethics and
Board Effectiveness at the University of Toronto’s
Rotman School of Management. Apparently,
they’re doing “badly enough that there’s been huge
growth in activist firms,” says Beatty, who
interprets that growth “as a direct comment on
boards of directors and their past performance.”
He ought to know. In addition to his academic
position, Beatty has served on more than
35 boards in five different jurisdictions and has
been board chair at eight publicly traded
companies. He currently serves on three boards—
one as chair—and is the leader of the Directors

Education Program offered by the Institute
of Corporate Directors. In a recent interview with
McKinsey’s Jonathan Bailey and Tim Koller,
Beatty discussed the role of corporate boards in
guiding and overseeing public companies,
offered recommendations for directors, and shared
his thoughts on the CFO’s role in working
with boards.
McKinsey on Finance: What do you see as
the most important change in the way corporate
boards function?
David Beatty: Frankly, we used to be pretty lazy
about boards. They were largely seen as being
rewards for past service. There was an assumption
that talented CEOs could move easily from
their executive posts into a board setting. The
boards were large and often perfunctory in
the performance of their duties. I have been on
the board of a large financial institution in a
developing economy that had more than 50 direc-
tors, and the main event was always the lunch
that followed the three-hour board meeting.
But a seat on a board is no longer a sinecure—
and the day of a board comprising solely gifted
amateurs is over. Partly because of external
circumstances, collapses, and stock-market failures,
there’s a growing sense that boards have to
be smaller, harder working, and more expert. And
they have to be able to commit the time to do
their work.
The last study I saw reported that directors were
spending an average of around 240 hours per
year across the S&P 500. That includes time spent
at home studying, committee time, and board
time. Today that number should be at least 50 per-
cent greater—and if a potential director can’t
put in 300 to 350 hours a year, she shouldn’t take
96 Role of the CFO: Selected readings for finance leaders
17
the job. But even 300 hours per year has to be
compared with the 3,000 hours a year that each
member of a management team devotes to his
or her work. And most managers these days have
spent a lifetime working in their industry. Even
a gifted amateur director who works hard is not
likely to be able to add much value to an
experienced management team about the day-
to-day business.
The only place outside directors can really add
value—aside from policing and oversight
functions—is in offering a different perspective on
the competitive environment and the changes
in that environment. That’s where their general
business judgment comes in, helping manage-
ment think through strategy and specific objectives
for three to five years down the line. That’s
where directors have their best chance of making
a difference.
McKinsey on Finance: On average, how well
are the boards of directors doing at most large
public companies?
David Beatty: Not well. Think of a long list of
disgraceful performances at the beginning
of this century—from Enron to WorldCom to
HealthSouth to Adelphia Communications—
and the recent collapse of the financial sector,
which destroyed an aggregate of $1.2 trillion
in shareholder value across the entire Organisation
for Economic Co-operation and Development,
and even of the more recent collapse of the mining
sector, which has obliterated over $600 billion
in shareholder value. You have to ask, “Where were
the directors?”
Boards of public companies have apparently
been doing badly enough that there’s been huge
growth in activist firms—which are in the
18 McKinsey on Finance Number 52, Autumn 2014

business of studying companies deeply, putting
their own money in, and then publicly advocating
a better way—to the advantage of shareholders.
I take that as a direct comment on the poor perfor-
mance of boards of directors in publicly
traded companies.
Part of the reason for this poor performance is
that the boards of many companies still don’t
know the businesses in which they compete. Board
directors are impoverished when it comes to
the competitive insights they can bring that might
make a difference. They’re also 80 to 90 percent
dependent upon management for the information
they get about the business, its competitors, and
alternative strategies. As a direct result, it’s not
uncommon for the CEO to assume control
of the agenda, arrange fairly anodyne planning
sessions, and be fairly closed minded about
the potential value the board can add.
CFOs have a unique capability to unlock the poten-
tial of the board. The CFO knows the numbers,
understands the businesses, and lives with the top-
management team but does not “own” the business
or businesses the way the operating managers
do. The CFO is therefore in a unique position to
work with and help the other members of the
C-suite understand the needs of the board and to
work toward making it effective.

David Beatty
Vital statistics Career highlights Canadian Coalition for Fast facts
Lives in Toronto, Canada University of Toronto Good Governance Has served as a director
(1997–present) (2004–09) on the boards of 35
Married, with 4 children Founding managing companies in Australia,
and 5 grandchildren Professor of strategic director of this group of Canada, Mexico, the
management, Rotman more than 50 institutional United Kingdom, and the
Education School of Management investors dedicated to United States, and
Holds a master’s degree in improving board has been chairman of 8
economics from Queens’ Director of the Clarkson effectiveness
College, Cambridge, Centre for Business Ethics In 2013, was awarded
United Kingdom and Board Effectiveness Peter F. Drucker a Queen’s Diamond
Foundation for Jubilee Medal for his con-
Has a bachelor’s degree in Founded the Directors Nonprofit Management tributions to the mining
political science in Education Program in (1992–2000) industry and received the
economics from Trinity 2004 and has since led the Vice chairman Order of Canada Medal
College, Toronto, Canada joint initiative with the for his work in corporate
Institute of Corporate Old Canada Investment governance
Directors Corporation
(1990–99) Has rowed competitively
Chairman and CEO with his wife in the
Fédération Internationale
Weston Foods des Sociétés d’Aviron
(1985–94) World Championships for
President many years

97 Role of the CFO: Selected readings for finance leaders

 Are you getting all you can from your board of directors?
“Talent and time are relatively easy components of
a chair’s task—the tough one is sensing and managing
the tone of the board.”
McKinsey on Finance: How do you see the role
of the board chair?
David Beatty: Benjamin Zander once observed
that he suddenly discovered at age 45 that as
conductor of the Boston Philharmonic Orchestra
he was the only person on the stage who didn’t
make a sound. His job, he realized, was to create
great things out of the individual talents that
were in front of him.
That’s also a really good description of the job
of a board chair: to bring out the very best in the
talent that is around the board table, both
the directors and the managers. A board chair is
responsible for bringing individuals with the
right mix of talent together, utilizing their time to
the greatest possible effect, and ensuring that
the tone around the boardroom is open, trans-
parent, and productive.
Talent and time are relatively easy components of
a chair’s task—the tough one is sensing and
managing the tone of the board. Tone breaks down
into two components: trust and tension. There
has to be trust around the board table among the
directors themselves, and there has to be trust
between the board and management. At the same
time, there has to be a certain tension between
the board and the CEO and the CEO and his or her
team, since they have different jobs to do. So
the job of the chair is to make sure everyone comes
together to make beautiful music.
98 Role of the CFO: Selected readings for finance leaders
19
McKinsey on Finance: Speaking of that
tension, do you think the chair and CEO should be
separate roles?
David Beatty: Yes, definitely. I can’t see
any excuse for the US practice. The fundamental
difficulty is that the same person can’t do
both jobs; it’s difficult for the fox to look over
the henhouse. And that kind of problem can
spread much deeper if a CEO fills other board
positions with friends and colleagues who
always agree with her or, for example,
appoints her personal accountant to chair
the audit committee.
The practice isn’t likely to change in the United
States, but there are work-arounds. A strong lead
director, for example, can take control of the
situation and ensure, over time, that a board is
independent of management. But it’s an even
tougher job than normal given the dual role of the
CEO and the chair.
If the lead director can’t establish an effective,
open, transparent, problem-solving, creative
interface between the board and management and
has done pretty much everything she could,
then she should resign. That’s what I’ve done in
those circumstances.
McKinsey on Finance: Short of waiting for a
crisis, what should a director do if the CEO isn’t up
to the job?
20 McKinsey on Finance Number 52, Autumn 2014
David Beatty: If the company is in difficulty or
if doubt begins to creep in about the CEO’s
effectiveness, a director needs to go into a different
mode—because if you’ve got the wrong CEO,
you’re out of business for three to five years. You
have to begin by talking to your colleagues to
see if others are also concerned. And study analyst
reports carefully to see how the company is
doing relative to its competition.
And talk to your chair. This is where the chair’s
responsibility for in-camera meetings after board
sessions can be hugely important. When I was
chair of the board at Inmet Mining, at the time a
$6 billion company, we’d invite the CEO to
stay after every board meeting—so we could ask
questions without other managers around.
Once the CEO left, I would canvass the board, one
by one, on what worked or didn’t work about
the meeting, what each would like to see
improved, and whether views on the CEO, if any,
had changed.
McKinsey on Finance: How long should
individual directors expect to serve on a board?
David Beatty: It’s very hard to get rid of directors,
so I am definitely in favor of term limits, what-
ever the cost. The United Kingdom has decided
that in publicly traded corporations, 9 years
is enough; they can extend that to 12, but from
9 years on, a director can’t sit on the audit
committee, the nominating committee, or the
compensation committee, so her functional
utility drops by about 60 percent, and typically
she just leaves.
That also brings up a question of board evaluations.
This is a practice that’s grown up over the
past decade, where boards formally sit down and
appraise themselves. That can be a paper-driven
99 Role of the CFO: Selected readings for finance leaders
appraisal, and it could be done in-house or by
third-party experts.
When I’m the chair of a company, I tend to
alternate between paper and personal. Every year,
I sit down with each director and run through
an extensive agenda of questions about the board’s
talent, use of time, and tone. Every second year,
I supplement that with a six-page questionnaire
that inquires in more detail about the functioning
of the board. I then use a third party to collate
those results and report to the governance com-
mittee so that any critique of the chair can
be included in the results.
Peer evaluations are not very common and can
often be problematic. The basic purpose is
an open and honest appraisal of colleagues against
certain performance standards. The peer
evaluation is designed to be helpful, not harmful,
to individuals. If somebody’s clearly under-
performing, it’s the chair’s job to figure that out,
seek out the advice of other senior directors,
and then act.
As chairman, I’ve asked two directors to leave
major boards, and it’s a miserable job. But in both
instances, I felt that the benefits of having that
person continue were greatly overwhelmed by the
potential costs. As a chair, I no longer use peer
evaluations but rely instead on continual contact
with my fellow directors.
McKinsey on Finance: Is there anything that
can be done to mitigate the social stigma of being
asked to leave?
David Beatty: Next to determining that your CEO
is significantly underperforming and needs to
go, asking a director to step down is the toughest job
there is. So, all too frequently, nothing is done.
Are you getting all you can from your board of directors?
Here, too, we may learn from activist investors.
Often, one of their first demands when they get
involved with underperforming companies is to
replace specific members of the board. It’s
also not unheard of for board members to resign on
their own after a testy proxy fight for control.
That’s kind of a disciplinary function that ought
to give spine and courage to chairs of boards
who are wondering about their board’s perfor-
mance, wondering about the performance
of individual directors, and trying to find that
courage to say, “On balance, we’re going to
be better off without this director or that, adding
some new talent that we don’t now have, and
asking him to move along.” It’s not easy. But again,
maybe the activists are teaching us that while
it isn’t easy, it might be necessary. And if you, as
chair, don’t do something, there’s a good chance
someone else will.
McKinsey on Finance: Some companies
are extremely complex. How does a board develop
enough knowledge to add value in such cases?
David Beatty: The job gets asymptotically harder
the bigger the company gets. The skill sets are
so demanding, the level of understanding so deep,
and the diversity of the company so profound
that it gets ever harder even to conceive of the board
adding value through strategic insight as opposed
to general business judgment.
A company such as GE, for example, is a talent
machine. The board’s contribution to the future
100 Role of the CFO: Selected readings for finance leaders
21
lies less in the arena of business strategy and more
in talent development and managerial succes-
sion. Directors see GE as an incredible university
of capable people whose talents they develop.
The oversight of that function, with respect to the
future of the company, is intense and highly
value added, versus the ability to say we should get
out of credit, we should be doubling turbines, or
we’ve got to move more deeply into China.
McKinsey on Finance: How can a board decide
whether a company is making the right trade-
offs between its short-term performance and its
long-term health and ability to grow?
David Beatty: This is another topic that I would
raise with the chair during in-camera meetings.
Say you’re coming out of a one-and-a-half-
day strategy session leading to decisions on capital
expenditures and a competitive way forward,
and you have anxiety about the timing. So, ask in
the in-camera meeting, “Did anybody else feel
that these investment decisions were being shaped
more from a share-price perspective over
the next six months than what’s in the longer- or
medium-term interests of the company?” Just
putting it out there as a topic for discussion can be
a powerful tool.
Interestingly, family-controlled companies in
Canada that are publicly owned have significantly
outperformed the rest of the market. It’s kind
of intuitive that they would have a longer invest-
ment horizon—you don’t invest in your kids’
22 McKinsey on Finance Number 52, Autumn 2014
education for the next quarter. By their nature,
CEOs of family-controlled businesses think longer
term than the hired gun you bring in from
outside to be the CEO and pay with a lot of options.
The average tenure of an external CEO in the
United States is around five years, and of course he
or she is thinking shorter term. You get what
you pay for.
Happily, most other markets in the world are
family controlled, so short-termism may be an
endemic disease only in the United States,
the United Kingdom, and some parts of Canada.
It’s structured into our system, and we’ve fallen
into the trap of measuring and compensating CEOs
against “the market.” Fortunately, we’re now
also hiring more from inside than outside—by a
ratio of about 70 to 30 for the S&P. That’s
a huge plus because it means you don’t have to go
into the market to attract, retain, and motivate
these gifted potential CEOs. But we’re probably not
going to get away from short-termism as long
as we have options.
McKinsey on Finance: What should the CFO’s
role be with respect to the board?
David Beatty: I have a radical proposition: I’m a
fan of the English system, where there are more
executives on the board than just the CEO. And the
first executive I would add to any North American
board would be the CFO. That would give the
CFO certain specific responsibilities with respect
to his or her relationships with the audit
committee, as well as with the board chair and
other directors. It would also significantly
enhance the quality of decision making around the
board table over the medium term and empower
Jonathan Bailey (Jonathan_Bailey@McKinsey.com) is a consultant in McKinsey’s New York office, where Tim
Koller (Tim_Koller@McKinsey.com) is a principal. Copyright © 2014 McKinsey & Company. All rights reserved.
101 Role of the CFO: Selected readings for finance leaders
the CFO to have an independent point of view—
not necessarily in conflict with the CEO, but simply
to have an honestly transmitted perspective
on the company.
Where that doesn’t happen, I’d encourage CFOs to
think about their relationship with directors from
the director’s point of view—and how they can help
directors do their job better. Certainly, a CFO
should let the CEO know she was planning to do
this, but she could reach out to directors
independently and ask them what they feel about
the quality of the material coming from her
department. Are the numbers just too intense? Do
they want more synthesis of what’s going on?
Would they like more in-depth analysis? The CFO
has the numbers and the intelligence and
understands the business without emotionally
owning the business.
McKinsey on Finance: What do you feel makes
the best CFOs stand out?
David Beatty: As a director, I like strong,
independent CFOs, not those who are deferential
to the CEO. I want a CFO who understands
the numbers, understands what’s behind them,
and stands up independently. I’ve served
on boards of companies with a CEO who had no
trouble with me asking the CFO for more
insight about this number or that, and the CFO
himself would have no difficulty interrupting
management meetings to clarify a point if it wasn’t
quite what he’d understood during audit-
committee meetings. So I really regard a strong,
independent CFO, in the handling of board
matters, as offering a great deal of value.
2

M&A as competitive advantage

Treating M&A as a strategic capability can give companies an edge that

their peers will struggle to replicate.

Cristina Ferrer, Most companies approach deal making as an art
Robert Uhlaner, and rather than as a corporate capability deployed
Andy West to support a strategy, and they see individual deals
as discrete projects rather than integral parts
of that strategy. Few have found a way to build and
continuously improve, across businesses, an
M&A capability that consistently creates value—
and does so better than competitors. As a
result, many lament how hard M&A is and worry
about the statistics highlighting the failure rate
of deals rather than how to build a capability that
helps them win in the marketplace.
At many companies, strategy provides only
In our experience, companies are more successful
at M&A when they apply the same focus, con-
sistency, and professionalism to it as they do to
other critical disciplines.1 This requires building
four often-neglected institutional capabilities:
engaging in M&A thematically, managing your
reputation as an acquirer, confirming the strategic
vision, and managing synergy targets across
the M&A life cycle. The ability to approach M&A
in this way elevates it from a tactical necessity
focused on risk management to a strategic capa-
bility delivering a competitive advantage that
others will struggle to replicate.
Engage in M&A thematically
vague direction on where and where not to use
M&A—and an unspecific idea of the expected
source of value creation. We often find companies

102 Role of the CFO: Selected readings for finance leaders


using M&A indiscriminately to purchase growth or
an asset, without a thorough understanding
of how to create value in a deal relative to others,
a so-called “best owner” mind-set. Rarely is
there an explicit link to organic investments or the
business cases for broader growth initiatives,
such as developing new products or building a sales
force to deliver an acquired product. As a result,
companies waste time and resources on targets
that are ultimately unsuccessful and end up jug-
gling a broad set of unfocused deals.
Successful companies instead develop a pipeline
of potential acquisitions around two or three
explicit M&A themes. These themes are effectively
business plans that utilize both M&A and
organic investments to meet a specific objective
while explicitly considering an organization’s
capabilities and its characteristics as the best owner
of a business. Priority themes are those where
the company needs M&A to deliver its strategy and
have the ability to add value to targets; they are
also highly detailed and their effect is measurable
in market share, customer segment, or product-
development goals.
Consider, for example, the M&A theme of one global
retail company: to grow by entering into two
emerging markets, acquiring only local companies
that are unprofitable yet in the top three of their
market. That’s a level of specificity few companies
approach. To get there, managers started with
the company’s strategic goal: to become the third-
largest player in its sector within five years,
something it could only achieve by aggressively
entering emerging markets. A less disciplined
company might have stopped there and moved on
to a broad scan for targets. But managers at
the retail company refined their M&A goals further.
They concluded that trying to enter too many
markets at once was impractical due to constraints
103 Role of the CFO: Selected readings for finance leaders
3
on management time and the complexities of
entering new geographies, so they limited their
search to the two most promising regions.
They also knew their lean operations would offer
cost synergies in companies with bloated
operations—especially given the importance of
economies of scale in the industry—and that
local branding and catering to local preferences
was critical. With their M&A theme defined so
precisely, managers were able to narrow the list of
potential candidates to a handful of companies.
Well ahead of its five-year schedule, the company
has successfully completed the acquisitions
needed to enter its targeted emerging markets and
has nearly achieved its revenue goals.
Manage your reputation as an acquirer
Few companies consider how they are perceived
by targets or how their value proposition as
an acquirer is better or worse than that of their
competitors. Many are too slow and reactive
at identifying potential acquisition targets, too
timid in courting and building relationships
with them, or too tactical when initiating conver-
sations. They may have such broad goals that
they can’t proactively approach a list of potential
targets. As a result, they end up being overly
dependent on targets proposed by outside sources
or burdened by constant fire drills around potential
targets. In many cases, they earn a reputation
among potential targets as opportunistic, process
heavy, and laden with overhead.
In our observation, companies that invest in their
reputation as acquirers are perceived instead as
bold, focused on collaboration, and able to provide
real mentorship and distinctive capabilities.
Even some of the largest and most complex organi-
zations are perceived as attractive buyers by
small and nimble targets, largely due to the way
they present themselves and manage M&A. The
4 McKinsey on Finance Number 47, Summer 2013
best among them tend to lead with deep industry
insight and a business case that is practical
and focused on winning in a marketplace instead
of on synergies or deal value. They let target-
company managers see how they fit into a broader
picture. They also have scalable functions and a
predictable, transparent M&A process that targets
can easily navigate. Finally, they are purposeful
about how they present themselves, supporting
executives with consistent and compelling materials
that demonstrate the best of the organization.
As a result, they are able to use their position in
the market to succeed in dimensions that go
beyond price—and are often approached by targets
that aren’t even yet “for sale.” This is a real
competitive advantage, as the best assets migrate
to the companies they perceive will add value,
decreasing search time, complexity of integration,
and the chances of a bidding war.
A big part of developing a reputation is managing
interactions and using them in a coordinated
way. It’s not unusual for companies to join confer-
ences, partner with universities that control
needed intellectual property, and talk to angel
investors and venture capitalists. But most
of them do so with no structure or understanding
of how many relationships they’re looking
for with which kinds of partners possessing what
specific attributes—and few of them do so to
build their reputation in the ecosystem around
potential targets.
To get it right, companies must be more purpose-
ful. At one high-tech company, for example, these
concepts came together around the theme of
enabling innovation. The company’s investment in
its reputation as an acquirer started with
a thoughtful external marketing campaign but
quickly made its way deep into the M&A
process. In discussions at conferences and in
104 Role of the CFO: Selected readings for finance leaders
engineering communities, managers used
testimonials from acquired employees and old-
fashioned jawboning to underscore their
track record at buying companies and providing
them with the expertise and resources they
need to accelerate their product pipelines. They
developed useful personal relationships with
target-company executives by discussing ways to
work together even beyond the context of a deal.
And when it came time to present integration plans
and future investment models to targets,
managers made sure they were consistent with
the acquiring company’s reputation.
Confirm the strategic vision
For many companies, the link between strategy
and a transaction gets broken during due diligence.
By focusing strictly on financial, legal, tax, and
operations issues, the typical due diligence fails to
bring in data critical to testing whether the
strategic vision for the deal is valid.
To do so, companies should bolster the usual finan-
cial due diligence with strategic due diligence,
testing the conceptual rationale for a deal against
the more detailed information available to them
after signing the letter of intent—as well as seeing
whether their vision of the future operating
model is actually achievable. A strategic diligence
should explicitly confirm the assets, capabilities,
and relationships that make a buyer the best owner
of a specific target company. It should bolster
an executive team’s confidence that they are truly
an advantaged buyer of an asset. Advantaged
buyers are typically better than others at applying
their institutional skills to a target’s operations,
marketing and sales, product development, or even
labor and management. They also employ their
privileged assets or proprietary knowledge to build
on things like a target’s brand, intellectual
property, financing, or industry insights. Naturally,
 M&A as competitive advantage
Companies can employ a number of tactical activities
to build a real capability at managing synergies.
they also turn to their special or unique
relationships with customers, suppliers, and
the community to improve performance,
leading to synergies that in many cases go far
beyond traditional scale synergies.
It is critical for executives to be honest and
thorough when assessing their advantages. Ideally,
they develop a fact-based point of view on their
beliefs—testing them with anyone responsible for
delivering value from the deal, including
salespeople, R&D engineers, and their human
resources and finance departments.
Such an approach would have helped one large
financial company that acquired an asset two
years ago to expand its services to regional clients.
Due diligence for the deal focused on auditing
existing operations rather than testing the viability
of the future operating models. The advantaged-
buyer criteria assumed by the company focused on
being one of the most effective operators in
the industry, supported by strong IT systems and
processes. Executives proceeded with the deal
without ever learning that the IT team had
a different picture of the eventual end state, and
they learned only after close that the two
companies’ IT systems could not be integrated.
Reassess synergy targets
Failing to update expectations on synergies
as the buyer learns more about the target during
integration is one of the most common but
avoidable pitfalls in any transaction. Companies
105 Role of the CFO: Selected readings for finance leaders
5
that treat M&A as a project typically build and
get approval for a company’s valuation only once,
during due diligence, and then they build
these targets into operating budgets. To drive
speed, efficiency, and simplicity, they either
have an overly rigid approach to integration, which
fails to recognize the unique attributes and
requirements of different deal types, or they are
totally unstructured, ignoring established
deal processes to rely instead on a key stakeholder
or gatekeeper to make up his or her mind. There
is rarely an opportunity to revisit value-creation
targets with executives, board members, and
other stakeholders.
The overly rigid or undefined nature of these pro-
cesses makes it hard to reassess synergies and
targets throughout the life cycle of a deal because
valuation targets are set early on and are virtually
locked in by the time integration starts. This
forces the organization’s aspirations down to the
lowest common denominator by freezing expec-
tations at a time when information is uncertain and
rarely correlated with the real potential of a deal—
overvaluing or undervaluing synergies more than
40 percent of the time, by our estimate. The reason
is simple: financial due diligence is conducted with
intentionally imperfect information, as each side
does its best to negotiate favorable terms in short
time frames, and it’s typically focused on likely
value instead of potential value. This is appropriate
for managing the risk of overpaying, but it’s
not the way an operator would actually manage
a business to maximize its potential.
6 McKinsey on Finance Number 47, Summer 2013

Managing this challenge can be complex but
worthwhile. One consumer-packaged-goods
company boosted run-rate synergies by 75 percent
after managers recognized that the target’s
approach to in-store promotions could be used to
improve its base business. One pharmaceutical
company raised its synergies by over 40 percent on
a very large transaction by actively revisiting
estimates immediately after the deal closed, creat-
ing a “risk free” environment for managers to
come up with new ideas, and throwing away initial
assumptions. A few years later, it had captured
those higher synergies.
Companies can employ a number of tactical
activities to build a real capability at managing
synergies. They might, for example, bring
stakeholders together in so-called value-creation
1 Long-term returns vary significantly by deal pattern and by
summits that mimic the intensity and focus
of a due-diligence effort but change the incentives
to focus on the upside. And we’ve seen expe-
rienced acquirers take a blank-sheet approach
to foster creativity, rather than anchor the
exercise in a financial due-diligence model, which
often leads to incremental synergies. These
and similar activities allow companies to reinforce
the idea that due-diligence synergy estimates
are the lowest acceptable performance—and get
managers used to setting their sights higher.
M&A is complex, and it isn’t the answer for
every strategic goal. Companies that can achieve
a strategic goal internally, with a sensible
investment profile and within a desirable time
frame, should do so and avoid the deal premium
and integration risk of an acquisition. But
those that can manage the complexity of M&A by
building the capabilities and insights required
to realize its full potential for growth can enjoy
an enduring competitive advantage.
industry. Companies with the right capabilities can succeed with
a pattern of smaller deals in most industries, but in large
deals, industry structure plays as much of a role in success as
the capabilities of a company and its leadership. See Werner
Rehm, Robert Uhlaner, and Andy West, “Taking a longer-term
look at M&A value creation,” McKinsey on Finance, January
2012, and Ankur Agrawal, Cristina Ferrer, and Andy West, “When
big acquisitions pay off,” McKinsey on Finance, May 2011.

Cristina Ferrer (Cristina_Ferrer@McKinsey.com) is a consultant in McKinsey’s Boston office, where Andy

West (Andy_West@McKinsey.com) is a partner; Robert Uhlaner (Robert_Uhlaner@McKinsey.com) is a partner
in the San Francisco office. Copyright © 2013 McKinsey & Company. All rights reserved.

106 Role of the CFO: Selected readings for finance leaders

2016
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