The following is an edited abstract from CFO Thought Leader’s “Ask Ethan” podcast featuring Ethan Carlson, CEO, Carlson Management Consulting, and Jack Sweeney, cohost of CFO Thought Leader.
CFOTL While frontline teams these days need to be responding quickly to changing events and opportunities, how does this impact the mind-set of organizations when it comes to long-term planning?
Ethan Well, from my perspective, having a long-range forecast or a long-range plan — something of greater than 3 years, say 3, 5, 7 years — is really a key component of the overall planning and forecasting process. It’s crucial to ensuring that the strategic alignment with your budget is maintained for a number of reasons. We see that having this in place allows organizations to have a thought process that’s focused not just on the immediate year’s results. In doing so, it allows the participants in the budgeting process or the planning process to take a step back and look at what the market looks like, what the macro trends are that they’re dealing with, and really be a little more thoughtful and strategic in the projections that they put in for what they want to accomplish.
It also allows people to — well, I don’t want to say take more risks — but to put ideas out there and to separate themselves a little bit from the process. Personally, I find that one of the big challenges in the annual budgeting process is that there’s a lot of gaming the system or sandbagging where a business owner won’t put forward their best projection because they know that hitting it is how they get paid their bonuses. So dealing or doing away with this is a great thing in that, often, these longer-range plans are not seen to have this same correlation, so people can often be much more transparent and can put stretch goals in place, which is really how organizations will evolve and improve.
I can think of one business leader I worked with for a number of years with whom we had to go through a 5-year projection as part of the beginning part of our budget process. Whenever we were doing our annual plan, he had more tricks up his sleeve — such as taking ways to hide backlog and things of that nature — so that he would always hit his annual budget and get his bonus. But when it came to the strategic plan, he was very thoughtful and did the market research and all that, so it was a very different process. So I think that this allows people to be more strategic but also to be more transparent on what’s possible in their business.
CFOTL Can you give us a sense of how organizations are modifying their approaches when it comes to long-term planning?
Ethan I think that the biggest thing that’s changing is the frequency and pace with which organizations are looking at longer-term projections. When I worked at GE a number of years back, we always had a long-range projection, but it was an annual exercise. I think that today this is happening much more frequently.
The pace of business that we’re dealing with, even in the last few years, has changed radically to where over the course of a week, or days even, a company’s outlook can change dramatically. Strategic events in the world or in their market can change and the long-term plan needs to be constantly reevaluated. What we’ve seen as much as anything is that the frequency of the model and the use of it is increasing. As a result, organizations are looking for ways to make this long-range projection easier and more accessible and more real-time.
CFOTL For companies seeking to adopt more advanced long-term planning approaches, what are some common mistakes to avoid?
Ethan Well, the first mistake we see is when a company goes to do a 5-year projection, say, and they try to do everything the same as they did in their annual process. They’re just doing it for 5 years, right down to the line item budget details. Who’s going to be hired under what seats? What are they going to spend on travel expenses and conferences? But this is a relatively pointless exercise. There’s no way that any of us has this kind of vision 5 years out into the future.
I think that if you want to have a successful long-range plan and you want to have one that aids the alignment of your strategy and your financials and how you’re allocating your capital, it needs to be market-focused first. You need to have the exercise start by looking at the market trends and have this as part of it. Then, it needs to be very driver-based. It needs to be those half-dozen to maybe a dozen key drivers that impact how your business is going to shift so that it’s accurate and meaningful, but also such that you don’t spend so much time and energy in updating it that it takes longer to update than its usefulness will merit.
CFOTL We hear from CFOs that a type of climate needs to be created wherein people can pursue long-term performance goals …
Ethan Well, I think it comes down to how you’re measuring success as an organization. If the only measure of success and how you’re doing is your current month’s or current quarter’s profit margins, this is not necessarily a culture where long-term strategy and investment are going to be valued. I’ve talked about this in a number of different ways throughout our sessions.
You have to have a balanced approach. All of the analysis and reporting and metrics that you’re measuring as an organization need to have balance. They need to have near-term financial measures. They also have to have non-financial metrics, and they have to have measures and ways that you’re looking at to make sure that you are making the investments that are going to be key to your future. I think a lot of this has to do with that balanced approach.
CFOTL We’ve been hearing as well that long-term planning demands more fluid mechanisms when it comes to reallocating capital or operating capacity. Can you give us an example of how companies have made these internal allocation mechanisms more fluid or flexible?
Ethan There are a couple of things that organizations can do. First, as you’re evaluating new initiatives or a long-range outlook for departments and how they’re going to allocate this capital, you need to have a somewhat standard model and approach. You need to have the metrics that you’re going to use to determine whether a project is something that as an organization you want to move forward with and have a standard for its return on investment, with key thresholds or things of that nature or other metrics. But it needs to be a relatively standard approach that’s easy to update. Then, every time you look at a new initiative, you’re not reinventing the wheel and putting together a new model.
Second, as you’re doing this, you want a model that’s interdependent. You want to have a full picture of your business and long-range outlooks with or without additional initiatives in place and have it so that you’re able to do scenario analysis. I mean, here in a long-range outlook is where scenario analysis can be some of the most valuable data. We talked about annual planning, where you need to have scenario analysis of a best, worst, and most likely case, at least.
I think that the same is true in long-range planning, where you want to see how your financials tend to look and what your probabilities of success look like if you pursue initiatives A, B and C, but not D — and what if you flip this around? Having an interrelated model that’s real-time and that you can update is really a key to making the allocation of your company’s resources in the most efficient manner.
CFOTL You talked about scenario planning. Is this something that we can talk a little more about?
Ethan Sure …
CFOTL Not to be too much of a skeptic, but it seems that when most companies do scenario panning, they’re really not doing scenario planning. They’re putting some guesses up on the board and trying some possible scenarios. But to do it correctly, what do they need to do? “Scenario planning” is thrown around quite a bit today, but do companies have a common definition of what they’re trying to achieve with scenario planning or what it is?
Ethan I think that’s fair. Scenario planning does have several different meanings. But I think that in this context, what I always would want to do is to say that you don’t know what the future is going to hold, particularly if you’re looking at a long-range plan. You should make sure that you know how you are going to react under different circumstances. Say that you have your baseline scenario, where everything is going the way that it’s supposed to. This is an easy long-range model. But what if there were a series of events that led to a 20% decline in your revenues? How would you react to that?
I think that an organization that has this plan in place, or at least an idea as to how they will react to an unforeseen event and have thought about it ahead of time — they’re at an advantage. Similarly, that’s not always in a negative context. How are you going to reallocate your resources if you all of a sudden have 20% more? Are you just going to go on a boondoggle, or are you going to do something meaningful with it? If you’ve thought about it ahead of time, if your organization has done this, I do think that you have an advantage.
CFOTL It looks like scenario planning would be fertile ground for us to cultivate next time, Ethan. Would this be an area that you’d like to tackle with us?
Ethan Yeah, I think that’s a great idea. I think it means a lot of different things to different organizations, and some are doing scenario planning for the first time or aren’t doing it at all, so I think that this will be a great topic for next week.
CFOTL We’re on board. Ethan, thank you for joining us on CFO Thought Leader.
Ethan: Happy to be here. I’ll talk to you next week.
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