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How key is finance to corporate strategy?

How key is finance to corporate strategy? I believe, in the interdependent and competitive world of the 1990s, the role of finance in supporting corporate strategy will be a determining factor in the success or failure of a corporation.

The recent events in Eastern Europe have demonstrated how rapidly and fundamentally the world is changing. But these developments, while sudden and dramatic, are in reality a continuation of significant trends that have been occurring for decades. It is our imperfect ability to understand the direction of these trends that makes events appear sudden and unforeseen.

What is important to finance in its support of corporate strategy is not the ability to forecast these events but to see the larger picture and to develop long-term strategies that not only allow for change but take advantage of teh changes. This is a form of corporate flexibility that is essential to the future success of an enterprise.

In recent years, high inflation and interest rates, the deregulation of financial markets, and the revolution in communications technology have brought us to a new state. The treasury function has evolved into an integral part of the strategic planning process. Because the dramatic changes in world markets are taking place with increasing speed, financial officers need to constantly reevaluate the structure and functions of the financial organization.

In the past, virtually all corporations stated as their primary goal to increase earnings per share, which would translate into higher dividends and a rising share price. But countless studies over the past 10 years have shown, to my satisfaction, that earnings per share can be a misleading measure. The emphasis today is on strategies that create the greatest value for shareholders over the long term.

Alfred Rappaport says in Creating Shareholder Value, "The shareholder value approach estimates the economic value of an investment by discounting forecasted cash flows by the cost of capital. These cash flows, in turn, serve as the foundation for shareholder returns from dividends and share price appreciation.

"The case for why management should pursue this objective is straightforward. Management is often characterized as balancing the interests of various corporate constituencies such as employees, suppliers, debt holders, and stockholders.... The company's continued existence depends upon a financial relationship with each of these parties.

"Employees want competitive wages. Customers want high quality at a lower than competitive price. Suppliers and debt holders each have financial claims that must be satisfied with cash when they fall due. Stockholders, as residual claimants of the firm, look for cash dividends and the prospect of future dividends, which is reflected in the price of the stock.

"If the company does not satisfy the financial claims of its constituents, it will cease to be a viable organization. Employees, customers, and suppliers will simply withdraw their support.

"Thus a going concern must strive to enhance its cash-generating ability. The ability of a company to distribute cash to its various constituencies depends on its ability to generate cash from operating its businesses and on its ability to obtain any additional funds needed from external sources."

If you agree with this argument, the role of finance in supporting corporate strategy becomes clear.

Managing for cash requires not only accurate and meaningful financial reporting of current performance, but also analyzing and forecasting new investments by business units in a framework that will determine whether shareholder value is being created.

The objective is to make better corporate decisions with respect to the allocation of scarce corporate resources and, equally important, to enable business unit heads to manage their businesses better. In my view, that requires a more active role for the finance function--at the corporate level and at the strategic business unit level.

In the past, finance people have been viewed as "bean counters," out of the business mainstream, with little to offer beyond saying "No." While we, as financial executives, certainly do not believe this to be the case, unfortunately the image persists. But it cannot continue.

One of our most important tasks as financial executives is to undertake an active, positive, cooperative relationship with fellow managers in marketing, operations, and all other areas of the corporation. This is not an easy task. It requires some risk-taking, because many view financial and operations people as dissimilar organisms.

Financial people are often considered not to be "business people" because they are not trained as chemists or salesmen or engineers, or they have never run a plant. Operating people, on the other hand, are accused of not having a financial perspective, of being concerned with only their own businesses and not taking a corporate view.

These accusations are part truth and part perception. But what do we do about the part that is true? The obvious answers are education and cross-training.

So what's the plan?

Ideally, financial people should spend a few years in an operating environment, and operating people should spend the same in a financial environment. Unfortunately, after years of restructuring and staff downsizing, the arguments often put forth are that the company is too lean, that it doesn't have the depth to transfer people back and forth, that it would run the risk that vital tasks would not get done or not be done well enough.

There is no easy answer to these arguments, but let me relate to you what we are doing at Hercules.

Last year, top management instituted a major corporate reorganization. It was designed to decentralize decision-making, enhance the company's productivity, focus more clearly on markets and customers, and position the firm to meet its growth goals for the 1990s.

Key features were to give heads of business groups broad autonomy, adopting a teamwork operating structure and philosophy, minimizing organizational layers, and keeping decision-making at the lowest appropriate levels.

The finance group was part of this reorganization. While there continues to be a corporate control group at Hercules, financial people have been put into each business group as controllers.

The treasury function remains centralized, but we have assigned senior financial managers as liaisons to each business group. The idea is to make the treasury liaison a member of the business group's team to support its stratery and help it succeed. We have placed the tecnical knowledge right next to the problem solver.

The liaisons have developed a broad understanding of the operations of their respective business groups. Each attends the general staff and capital project meetings of the group. And we are able to provide centralized treasury support to the business group at an early stage. This has greatly reduced conflicts.

But our objective is to go beyond reducing conflicts. We want to achieve a cooperative and interactive relationship, to help avoid problems and speed our problem solving. Some would call this quality improvement.

A recent article in The Harvard Business Review, entitled "Must Finance and Strategy Clash?," addresses some of these issues. As the authors point out, "good investments come from a detailed understanding of both the market and the company's operating and competitive capabilities.

"Used sensibly, finance helps bring these into the open. Financial analysis also helps clarify a project's boundaries by addressing issues like the base case, the time horizon, and future strategic opinions--all of which are as much strategic and market based as they are financial. Finance gives them a common language and framework."

Intertwined with our efforts to support the business groups at Hercules are the corporate responsibilities of finance. We are the stewards of the corporation's assets. How do we protect them? How do we support overall corporate strategy? How should we relate to the outside world? How do we organize for the 1990s and beyond? What shoudl we be doing?

Responding to trends

"Globalization" is the word on everyone's lips these days. Certainly not every company needs to have a global strategy, although some firms may be a part of someone else's global strategy. Indeed, more and more of us are becoming part of European or Japanese global strategies. Some companies, because of their markets or products or some other factors, may face little competition from abroad. But such companies are becoming fewer and fewer.

Business International, a research and publishing firm, notes five megatrends in the global financial environment. They are:

* The growing deregulation of financial markets.

* A world economy in flux.

* New trends in corporate organization.

* The changing dynamics of the international banking system.

* The electronics revolution.

These, of course, are not separate trends but are very closely connected. In responding to the trends, companies face two challenges. First, we need to train and organize ourselves for the new financial environment. Second, we need to develop a more opportunistic, transaction-oriented posture, the net result of which will be to become more financially assertive, active, and competent than ever before.

Training begins with hiring the most talented, committed people. I thing that close, informal working relationships are needed at all levels. A team approach to problem solving and pushing responsibility down to the lowest appropriate level fosters a very positive environment. And we need highly skilled people to do this, not a room full of clerks.

Training is a continuous process of education in light of the multitude of new financial instruments and techniques. At Hercules, we believe that through in-house programs and close relationships with the outside financial community, we keep up to date.

And I'm a firm believer in a centralized treasury function. While Hercules' operations have become more decentralized, finance continues to be centralized.

STrong arguments can be made for this strategy. First, centralization reduces borrowing and foreign exchange costs. The corporation can borrow less expensively than a subsidiary, take advantage of a wider range of financing techniques, and save transaction costs in foreign exchange through netting systems. Second, centralization concentrates financial expertise--a scarce resource. For example, how many good foreign exchange managers are there? Certainly not enough to put in every subsidiary or business unit. Further, you end up taking offsetting positions. Third, centralization reduces risk. A lack of expertise can lead subsidiaries or business units into borrowings or foreign exchange transactions that can greatly damage their profits.

But, if a strong case can be made for centralization, should you take the next step and make the treasury function a profit center?

I think finance's major roles are to protect corporate assets, provide liquidity, and avoid losses. Often, companies look to foreign exchange to provide profits. Hercules has a very good foreign exchange manager, and, as a result, we have done very well managing our foreign exchange position. But does that mean we should turn foreign exchange into a full-fledged profit center and go up against the round-the-clock trading operation of Chase Manhattan? I don't think so.

Before a company undertakes profit center activities, it must make certain the proper skills exist. The process may look easy, but there are real risks that must be understood and managed.

Hercules has used safe harbor leases to reduce taxes, foreign currency options to minimize foreign exchange exposure, and export trading companies to contribute to corporate earnings. We even run our real estate department at a profit. But our real job is to make the business run better, and we should not be diverted onto conflicting paths.

The financial function is more than just keeping the books. It is more than just analysis. It is more than just trying to lower borrowing costs or minimize foreign exchange losses. It is about being part of the whole picture at both the macro and micro levels of the corporation. It means getting involved at the beginning, working with business units as tthey formulate strategy. It means being positive, active, innovative, and supportive.
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Author:Engebretsen, Arden B.
Publication:Financial Executive
Date:Jul 1, 1990
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