Driving Business Growth: Profitability Strategies for CFOs

A Gartner survey of CFOs found that around 80% planned to maintain or increase digital investment levels in 2023. Despite continued spending and continued expectations that digital investments will drive business growth, only 33% of CFOs report that digital spending has met or exceeded expectations. Revenue attributed to digital is, on average, between zero and 5% of total enterprise revenues, for instance, and productivity has flatlined since 2015.

Those are averages, however. Some organizations are meeting or exceeding expectations from digital spending. Those that do outperform those that don’t by 2.8x. These superior returns are the combined result of two key actions: digital discipline and digital cohesion.

Digital discipline delivers about 41% of the value realized by the organizations that meet or exceed digital expectations. It requires finance to:

• Vet business cases for digital spending

• Collaboratively define KPIs for new digital projects

• Hold business leaders accountable for digital outcomes

Digital discipline is difficult to achieve, however, due to the fact that finance leaders typically lack familiarity with digital business cases and don’t know what the right KPIs should be at the outset of a new initiative. Moreover, digital investments are often cross-functional, requiring input from multiple business units; holding one business leader accountable for outcomes overlooks the diffuse responsibilities and benefits that digital capabilities enable.

Efficient growth leaders — defined by Gartner analysis of more than 1,000 S&P Global 1200 companies — have sustained long-term revenue growth with simultaneous margin improvements over the past 20 years. They see a 7.1% return premium over their peers. These companies are rare. Since 2010, only 5% of S&P Global 1200 organizations fall into this category. The ones that do embrace the following growth practices:

• Instill cycle discipline. Plan around all four phases of the business cycle: stable growth, peak, recession and trough. This means that organizations still seek to reduce operating costs when economic growth is strong and invest in opportunities when it’s weak.

• Remove growth anchors; preserve growth ladders. Make bigger, riskier growth bets to deliver outsized growth over the long term. Examples include pursuing larger M&A deals as a percentage of revenue, prioritizing R&D spending on transformational innovation, and reintroducing capital expenditures faster after a recession than their control peers.

  At the same time, finance must remove growth “anchors,” which cause business managers to redirect resources away from growth projects — such as lengthier evaluation processes for higher-risk projects, resulting in delayed project funding.

• Cultivate overperformance instead of correcting underperformance. Finance teams tend to focus on minimizing the number of investments that miss their initial expectations rather than maximizing their total returns. As a result, they spend a disproportionate amount of time and resources vetting business cases, holding business leaders accountable and course-correcting underperforming investments. These actions don’t produce the desired results.

  Instead, the most successful finance teams adjust the planned level of funding so they can pull back on underperforming investments and add funds to higher-potential opportunities. They also minimize resource interdependencies between projects. As a result, these companies achieve the desired internal rate of return (IRR) on their overall investment portfolio.

• Focus on scale, not scope. Most companies inadvertently add scope as they pursue growth. This creates complexity that inflates cost structures and weakens competitiveness. Efficient growth companies, in contrast, compete in fewer industries, book more revenue in their largest geographic segments and consolidate their products and services into fewer lines of business than their peers. As a result, they achieve 10-percentage-point higher operating cost productivity, as well as cost reduction periods that last for almost 40% longer.

• Pursue cost differentiation. Adapting the cost structure to extrinsic factors based on the growth plans of the CEO and business unit executives — all driven by the opportunities and dynamics in their markets — has been touted as a key CFO leadership practice. But Gartner analysis found that adaptiveness has zero impact on a company’s ability to realize long-term value. Differentiating the cost structure based on intrinsic factors, in contrast, produces an average return premium of six percentage points.

The competitive pressure to drive top-line business growth has caused costs to outpace revenue. CFOs are urgently seeking ways to translate long-term growth bets into sustained profitability. Beyond adopting growth practices, efficient growth companies achieve profitable growth by focusing on scale in the cost structure instead of on scope.

That focus on scale shows up in the following activities in efficient growth companies compared to similar-size competitors. These companies:

• Invest in 18% fewer industries in their business portfolios and pursue adjacent expansion only when they can leverage fixed costs

• Structure product and service lines into 24% fewer segments, focusing overhead investment on a simpler product and service mix

• Concentrate customer acquisition and operational footprint, deriving 20% more revenue from their largest geographic segments

Overall, these activities deliver faster earnings growth relative to revenue.

Embracing these practices can present a complex challenge, however. This is especially true for organizations pursuing a business growth strategy through M&A, entering new markets, and developing new products — all of which require investment in operating costs. For example, when organizations diversify into adjacent industries, CFOs are forced to spread fixed costs across a wider array of product and service lines and geographic segments. This decreases the leverage companies can achieve from functional and operating costs.

CFOs facing pressures on business profitability often turn to cost cutting to protect the bottom line. However, these actions could inadvertently damage in-progress growth investments — the very thing that can help steer the organization safely through a challenging macroeconomic environment. 

The need to protect business growth during uncertain times is clear, but it’s not always clear which investments will need extra funding and when they will need it. That challenge is exacerbated when resources are harder to come by. Progressive CFOs implement strategic cost management techniques to ensure key investments have sufficient resources by:

• Reallocating funding from low- to high-potential investments. Sourcing funds from low-performing and low-potential investments is an effective way to support the most promising in-progress growth investments when additional funds are not readily available. In fact, the ability to reallocate resources to the projects that need it most is one of the hallmarks of efficient growth organizations. These organizations succeed in part because of their ability to cultivate overperformance by helping growth bets exceed their initial expectations.

• Funding growth investments using a cost-saving winback mechanism. Winbacks are a mechanism that enables business units to regain a portion of their cost savings. They are a win-win for CFOs looking to incentivize cost reduction in a way that doesn’t hamper in-progress growth investments. They work because they help strike the right balance between two often competing priorities: promoting cost reductions and protecting in-progress growth investments. By deploying earned winback funding back to in-progress growth projects, business units can provide funding to these investments when they need it. This opportunity to secure funding for their investments further motivates business units to reduce costs sustainably.

• Using unallocated funds for as-needed growth investment support. Taking advantage of unallocated funds can provide tactical support for growth investments. Ideally, set this as-needed funding aside as part of the annual budgeting process. However, as intentions to increase in-year budget flexibility continue to grow, it should be possible to apply this technique outside of the annual budgeting cycle.

One of the biggest barriers to executing on a digital strategy is inappropriate funding. Only 24% of companies have modified their funding processes to better support digital investments. As a result, organizations are slow to dedicate resources to, and shift resources among, digital initiatives.

As a greater proportion of digital spending shifts from capex to opex, linear funding processes require digital initiatives to be planned in detail up to a year in advance. This slows digital business acceleration and hinders the agility that digital investments require. 

To dedicate the necessary resources toward digital business optimization and transformation outcomes, align digital funding to products rather than projects. While project-based funding locks resources into a plan, product-based funding results in flexibility and strategic resource allocation toward the most important business capabilities and outcomes. Eighty-four percent of organizations plan to adopt a product funding model for parts of their business over the next few years. 

In a product funding model, products are defined broadly as capabilities, services, platforms or goods for a particular customer segment, classified by their value and how they are consumed. The target customer segment for a given product can be either internal or external to the organization. Businesses commonly structure product lines around business enablement, competitive advantage capabilities or phases of the customer journey.

To move to a product-based funding model for transformational digital investments:

• Set funding targets that direct disproportionate funds to the most important digital transformation and optimization product categories and lines by establishing and ranking digital strategic pillars and using relative weights when assessing investment options.

• Build comfort around uncertainty on digital investments by adapting business cases to accept outcome ranges, and map out what is uncertain and what will be learned as initiatives progress.