CFO Roundtable February 2012

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Between the first and second day of the Economist CFO Summit 2012, 4C assembled a group of senior finance leaders from different industries at The Savoy Hotel,
City of Westminster.

Attendees included Teuta Bakalli, FD, Vanguard Asset Management, David Fry, CFO, North and South East Asia, Pepsico, Richard Jones, FD, Anglia Regional Co-op, Kazimierz Przelomski, Vice-president and CFO, Selena Group, James Welsh, FD, A&N Media and Lance Younger, CFO & Regional Office GM, Goldman Sachs.

The event was chaired by Ed Ainsworth, 4C’s Managing Director.

The session covered four main topics:

1. Managing and reacting to risk
2. The link between cost, margin and shareholder value
3. The challenges brought about by the current economic environment
4. New IT Practices and Cloud Computing

The discussion raised interesting insights regarding risk management, the benefits of protecting market share, the volatility of the current economic climate and the future of IT.

Managing and Reacting to Risk

Economic risk, linked to low inflation and high volatility, and supplier risk are not new issues for businesses, however recent events have seen both become increasingly important for CFOs. One participant listed operational failures, the risk of unpredictable events, market change and the difficulties of effectively managing capital as the four key areas CFOs are currently focused on.

One potential solution to managing risk is insurance. The issue is that the need for effective due diligence in the context of unforeseeable circumstances means some claims only serve to mitigate damages. One participant pointed out that in some cases insurance was taken out solely to “give a good signal” when looking to secure an investment from a third party.

One participant raised the issue of managing risk in locations which are highly susceptible to natural disasters. The unpredictability of events such as floods, earthquakes and even non-natural disasters such as fires make it difficult for businesses to effectively plan ahead. Although it is impossible to foresee events which are effectively unpredictable, a flexible supply chain was suggested as the best possible solution.

“The real problem with managing natural disasters is that they are unpredictable and it is difficult to be anything other than reactive. How can you plan for floods, earthquakes and tsunamis?”

In this context it is important for finance leaders to balance the pros and cons of a supply chain which incorporates multiple suppliers. One participant gave the example of Zavvi, Britain’s largest independent music retailer, which despite increasing its revenue by 10% in 2008 went into administration. The reason behind this was the decision to rely on just one supplier and the lack of an appropriate contingency plan. As a result when Entertainment UK closed down, Zavvi lost its single supply of CDs and DVDs and went out of business.

Another issue raised was the impracticality of dedicating a team to managing unpredictable risk. “A lot of the time it seems to be a case of closing the stable after the horse has bolted,” said one participant. Ed Ainsworth suggested that although it is difficult to prepare for everything, resilient supply chains and multiple, unconnected suppliers are the best option for companies.

Cost, Margin and Shareholder Value

The discussion switched to the link between cost margin and shareholder value. Most thought that a key focus for a company is to balance its position as a market leader with that of a margin leader.

“It is difficult to convince shareholders that it is in their best interest to decrease margin in order to remain market leaders but market share is worth protecting.”

Striking the right balance between market leadership and high margin is complicated and a wide range of factors need to be taken into consideration. Large companies are faced with the difficult challenge of maintaining market leadership and value. This can be trying as it is sometimes necessary to decrease margin in order to maintain market share and consequently ensure the long term future of the business.

The relationship between profit and value is not straightforward.  Research has shown that companies with a higher margin in their industry are able to achieve a higher value multiple (or PE ratio).  It has also been demonstrated that the highest margin market participant will trade at the highest multiple.  On the other hand, this must be set against growth, and reducing margin to achieve growth may ultimately devalue the business.

However, one participant argued that trading margin for market share often raised company value. Market leaders are in a powerful position as they are able to make certain sacrifices in order to maintain their leadership.  It was suggested that a market leader could drop to between 10% and 20% of margin – but no more- in order to remain one of the top margin leaders whilst maintaining market leadership.

In this environment, effective communication with analysts to explain the reasoning behind actions was highlighted by one participant as key to long term success for the company. Several present agreed but felt that analysts did not look at the long term picture when judging financial strategy and were quick to draw conclusions regarding decreasing margins.  Firms backed by private equity have fewer difficulties building a dialogue with investors and agreeing a longer term strategy.

Balancing the long and short-term ramifications of prioritizing either market share or margin is a key consideration for finance leaders. Companies with limited shareholders will find it easier to favour the long term development of the business whereas CFOs in large corporations may have to convince analysts and investors why less now can mean more later.

Challenges due to current economic environment

Participants based in the Eurozone were fairly downbeat about the economic situation and echoed the poll from the CFO Summit in which the majority of attendees felt Greece would leave the monetary union. Some went further and suggested that the exit of several countries from the Eurozone was extremely likely and that this would lead to severe financial complications.

On the other hand, some of the participants from outside the Eurozone were positive about the continued economic development in their territories. India, Poland, Russia and Thailand were all mentioned as nations experiencing positive economic growth. China was unsurprisingly singled out as a country with huge potential however the likelihood of political unrest was highlighted as a possible obstacle to sustained growth.

“We might end up in a situation where luxury European cars are being exported to China and cheap Chinese cars are being shipped to Europe”.

One perspective was that in an increasingly connected world it is impossible for every territory to experience growth simultaneously.

Attitude and Survival

Attitude and a willingness to survive and make sacrifices will determine how countries will emerge from the current financial turmoil. Greece was given as an example of a nation which did not seem willing to “sell the crown jewels” in order to get back on track. There was little doubt amongst the participants that the losses of the more developed nations would translate into opportunities for emerging markets.

Kodak was used to illustrate the danger of resting on your laurels and failing to innovate in a harsh environment. One participant said; “There will always be winners and losers and any complacency will be taken advantage of”. B&Q was given as an example of a company that has been able to evolve with the times and remain ahead of its competition. Continued innovation and determination are the key attributes necessary for businesses and nations to prosper in the current financial climate.

New IT Practices and Cloud Computing

IT was singled out as an area which could potentially offer huge savings for businesses. Two main themes were discussed; cloud computing and the use of personal (i.e. non company) devices.

With companies increasingly adopting smaller and less powerful laptops, tablets and smart phones, the onus is on ever present and accessible servers to carry out the processing activity. Cloud computing will enable businesses to generate savings in IT by providing a cheaper and more flexible alternative to current virtual storage models.

One participant explained that his business had recently decided not to renew a contract with a virtual storage company and was currently looking at cloud based alternatives. The difficulty was implementing such a new system across a large organisation. SMEs, it was argued, are in a prime position to take advantage of the benefits offered by cloud computing.

“Cloud computing is a great option for SMEs but in the short term will be difficult for large organisations to implement.”

The conversation then switched to the pros and cons of giving employees the option to work from their own devices. The potential savings for employers are huge, particularly in growing businesses where new hires require the purchase of additional equipment. In addition many employees would favour the approach as it allows them to work using the platform they are most comfortable with.

The downside of a “Bring Your Own Device” (BYOD) policy is creating a server which is flexible enough to work with an array of different devices but also capable of maintaining a certain degree of security. This challenge could result in a culture divide between the IT department, who are responsible for data security, and the rest of the employees.

Two key considerations for businesses regarding the adoption of new IT practices were highlighted by the participants. Firstly companies must ensure that they continue to work on rolling out increasingly simple business processes to improve efficiency and make use of standard software. Secondly, regardless of where and how systems are hosted, cost must remain under control and ideally reduce year-on-year.

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