Strategy In Action: Kill RoB, Pt. 1
Executives spend an inordinate amount of time thinking about strategy. They ask, “what can we do that customers want and that no one else can do?” Leaders should spend a ton of time answering those questions with precision and intent. Strategic work is essential.
At the same time, 99% of an organization’s resources go to running the day-to-day business. You may have 50 executives thinking strategically and 4,000 people working to get things done. How the 4,000 get things done, why they do what they do, and what ‘good’ looks like is all operations. Operations is not commonly considered a ‘strategic’ function. Indeed, there is a frequent and facile split between “write the plan” and “execute the plan” (hint: it’s never that clean cut). Whether the organization is aware of all the processes driving those 4,000 people, there is a ‘playbook’ in effect for what those people are doing. And whatever strategy management wants to be in effect has to be embodied in that operational playbook.
This is the biggest gap I’ve observed in business leadership: the space between high strategy and daily operations. How do we translate strategic aspirations into what the team does every day?
As my sister is fond of saying. “All great ideas dissolve into work.” And in corporations, the great strategic ideas often dissolve and disappear when they hit the existing operational playbooks. Leaders come up with great strategies, everyone agrees, and then promptly go back to whatever they were doing the day before. There is a military strategy saying: “no strategy survives encounter with the enemy” (I don’t know who said it, but I hear it all the time). In business leadership, no strategy survives encounters with the existing day-to-day operations playbook. That’s the focus of Strategy In Action: how does great strategy become great daily work?
Our technology-driven dialogue focuses primarily on product design and often overlooks the strategic importance of the Finance department. So much of company culture is driven by Finance and many product and business leaders think of Finance as a service business, simply supporting whatever the business is trying to do. Remember that Finance writes the story for executives, the board and investors. Finance presents the view of reality that management relies on when making decisions. And as the last person with the pen, the Finance department is de facto one of the most powerful departments in the company. This is especially true when it comes to implementing strategic change. Unfortunately, because of the culture of being a standard bearer (GAAP, CPA) and the emphasis on consistency over logic, traditional Finance departments are inherently conservative and resistant to change. They also tend to be under-funded and so deviations from routine processes aren’t often welcome.
While Finance encompasses many sub disciplines (e.g., tax, accounting, treasury) every central Finance function has what is called the “rhythm of the business,” or a “RoB.” RoB is the annual cadence of financial reviews and planning tasks. In my experience, the RoB is often under scrutinized from a process design perspective, defaulting to financial mechanisms and practices, informed by standardization and tradition, not strategy. At its best, the benefits of a traditional finance RoB are limited to executives, board members and investors, and rarely extend to the 4,000 people doing work. At its worst, it’s a baffling time-sink that takes energy away from running the business.
As a business unit operator, I’ve long fantasized about eliminating the RoB. Too many times, I’ve had a Finance person send out a schedule and templates for me and my team to fill out, often last minute with short deadlines and wide-ranging asks. It’s something we have to do for someone else that doesn’t help us do our jobs. (The only worse thing that having a template shoved in your face with an unreasonable deadline, is having budget numbers handed to you with no dialogue or input. Please avoid both these situations.)
I set out to write a single article on this topic, but it is taking more time to discuss than I expected. So I’m breaking it into multiple articles. Part 1 explains what the RoB is and how I’ve experienced it so far. By the end of Part 1, I will propose changes to better put Strategy in Action. Part 2 will break down how to make those changes. I’m not sure how many Parts there will be, I’ll know once I write Part 2.
So what is the RoB?
Generally, an RoB is comprised of four processes: ‘Close’, ‘Forecast’, ‘Budget’, and ‘Three Year Plan’ (3YP).
Close is the process of “closing the books,” which refers to all the bookkeeping and accounting required for a time period that just finished. It happens at least monthly, so there are at least twelve ‘Monthly Close’ cycles. Monthly Close is a flurry of generating reports, ensuring General Ledger (GL) entries are made so that all financial transactions (money in or out) that happened during the month are accounted for properly. Once the numbers are accurate, then different layers of department heads review them and write narratives to describe what happened. Those narratives are consolidated and presented up the management chain in a series of ‘Monthly Business Reviews’ or ‘MBRs.’ Depending on the size, life cycle and culture of the organization, MBRs can be small affairs with a handful of leaders, or intense, high pressure series of meetings and lengthy writing exercises, taking hundreds or hours of executive time every month.
The purpose of a Monthly Close is to give management a financial view of the business as of that point in time. It is how they can look at the progress so far in the year and make adjustments if necessary. Capital allocation is the first step in translating strategy into action. If you have a great strategic idea, you will have to put your money where your mouth is to realize it. Think about how the Monthly Close will show up and determine decisions to allocate capital to the new strategy.
The Monthly Close process is usually a sprint in the first week of the month following the close month. As of 12:59pm the last day of the close month, reports can be run, data can be gathered and the close process can begin.[1] There is pressure to close quickly because management is waiting to see what happened and whether they are on track for the year. I’ve seen close processes take four days on the fast end to two weeks on the long end. It tends to depend on reporting sophistication and the tools available in the financial system of record. The more modern and sophisticated, the faster. The older and more manual, the longer it takes.
Note that if the MBR happens too late in the following month, it will be useless as so much time will have passed since the previous month that no actions can be taken. Conversations will devolve into questions about what happened in the intervening time. For example, if management isn’t discussing January financial results until February 17th, and they care about daily or weekly operations, almost three weeks will have passed since the information they are given has happened, i.e. the Monthly Close docs for January are out of date. Not all businesses have this problem if their product and customer cycles have a longer horizon, i.e. a three week old financial performance report might be timely. But for software, services, retail and always-on businesses, a financial view of the business that is more than seven days old is historical.[2]
Also note that if the Close process takes two weeks to produce, present and absorb, then your leaders are literally spending 50% of their time looking backwards and trying to figure out what happened and why. For the middle managers and executives, they feel like all they are doing is talking about the past. It’s an MBR treadmill: two weeks off, two weeks on, two weeks off. It’s not the best use of the highest paid folks in your organization. You want a short Monthly Close, ideally done with in the first week of the following month.[3]
Every three months, there is a second close process added to the Monthly Close: the Quarterly Close. The Quarterly Close is a summary of the Monthly Close, same source data, just rolled up for the three months in the quarter. It’s conceptually simple, but is a separate set of calculations, reports and commentary to write. Now with Monthly and Quarterly Close, how many processed do we have for the year? 12 + 4 = 16. Now add the Annual Close for 17.
For your organization, do the math on what that costs. Say each close cycle takes 5 hours from 5 people in Finance at $60/hour ($1,500), 5 hours from department heads in 3 departments at $120/hour ($1,800) and 2 hours from 10 people to sit in the MBR and $80/hour ($1,600). That feels very low to me, but that would be $4,900 per cycle, times 17 = $83,300 a year for close cycles.
Next is the Forecast process, where the organization predicts what is going to happen for the remainder of the fiscal year. Forecasts don’t usually happen every month, usually quarterly (there are normally 3 Forecasts per year: Q1, Q2 and Q3. The last one of the year turns into Budget). Forecasts take more time across the organization than the close process since central Finance relies on the business units to do most of the work in terms of updating revenue and expense predictions. Note that in some organizations, Finance does the forecasting and gets input from the business units. In others, Finance expects the business units to just give them numbers. It depends on the predictability of the business and the sophistication and staffing of the central Finance team.
But let me declare the RIGHT way to do a forecast: require the business unit leaders to drive it. When a central Finance department does the majority of a forecast, they miss the opportunity for the business unit leaders to reflect on their business and the business unit leaders aren’t invested in that updated number. Have you ever heard this phrase? “That’s not MY number, Finance made that up without talking to me.” Believe me, you do not want to hear that from your leaders.
Accounting for RoB so far: 17 Close cycles plus 3 Forecast Cycles = 20 RoB cycles.
The next two: Budget and 3YP are only +2 cycles, but these cycles are HUGE time investments.
Budget is an annual capital allocation exercise. Whereas close and Forecast are tracking and adjusting to an existing plan, Budget is the process by which you set the new operating plan for the next year. Ideally, Budget is matched with an Operating Plan (Amazon calls it OP1 and OP2, their annual Budget planning before and after holiday). The idea is that you know what you’re going to do (Operating Plan) and you have the money going to the right places to produce the desired financial results (Budget). Budget becomes an entire “season” that starts in the Fall and goes until the end of the year, ideally, and often into the beginning of the new year.
And whereas Close and Forecast are largely accounting and math exercises, Budget is a cross-organization negotiation about commitments, accountability and performance. Budget directly impact leader’s compensation, continuing investments, and strategic trade-offs. Leaders spend an ENORMOUS amount of time crafting, discussing, negotiating, rolling and re-rolling Budgets until everyone has had their day in court and it gets locked for the year. And if there is a board, it isn’t locked until the board has approved it (remember boards really only have two jobs: hire executives and approve annual budgets). As a business unit leader, I could easily spend 100 hours over three months on Budget models, meetings, discussions, revisions, versions, bridge explanations, strategic research. Whatever Monthly Close takes in terms of hours, multiply that by fifty for Budget.
3YP is current-year Budget plus two years. The 3YP becomes a long-term strategic transformation planning exercise. Unlike Budgets, 3YP tend to involve fewer people and is more numerically driven for senior executives, the board or investors. Because you have less granular visibility into what is happening 24 months from now, you don’t forecast it the same way and you don’t need the same organizational commitment as for what happens in the next three months. A central Finance team is more qualified to do a 3YP by high level abstractions in financial taxonomy. That said, good 3YP are driven by the operating unit leads similar to Budget.
If Monthly Close is an effort unit of 1, Budget is a 50 and 3YP is a 20. Let’s add up the cost of the four parts of RoB (Close, Forecast, Budget and 3YP) using Matt’s abstract units of effort:
· Close = 17 (1 unit * [12 Monthly Close] + [4 Quarterly Close Cycles] + [ 1 Annual Close Cycle])
· Forecast = 6 (2 units * 3)
· Budget = 50 units
· 3YP = 20 units
· Total: 93 Units of organizational effort for the RoB.
If 1 unit = $5K, then a normal RoB system is $465K. And that is for a small company with only 5 impacted Finance folks, 3 business units and only 10 people involved in MBRs. For a big organization, it is more likely in the millions of dollars a year spent on RoB. And that’s not counting the attention opportunity cost for the organization.
Much of that money is well spent. After all, the RoB is how companies do strategic and financial planning. That is the essence of business management and capital allocation. You have to do that to claim you a “running a business” at all. And because the RoB is the financial view into performance that drives capital allocation decisions, it is critical to strategic change. That said, I believe traditional RoB approaches are too expensive and not very effective in implementing evolving strategies. Here is how to make them better:
1. Integrate the Financial P&L model with the Operating Units KPIs and Dashboards (call that a Data Table for now). This will connect the operating playbooks metrics to the central Finance P&L and massively increase understanding of how the business works.
2. Engineer adjustments and forecasts into the Data Table so it is automatically updated with, and based on, actuals. If you have to do something more than once, you should write code.
3. Extend the forecast horizon to a rolling three years at a monthly level, and
4. Cancel everything except Monthly Close.
This approach would align operational and financial metrics, enable you to cut the effort significantly. There would be no more Budget Season, no more Forecast cycles, no more 3YP. All those views would be in the 36-month Data Table already. The Data Table is largely updated automatically due to good data engineering, clear mental models and a focused audit effort every three weeks.
Want to know what 2022’s revenue target is? What to know how many headcount this business unit expects to need to hit that revenue target in 2023? Answers to ANY of those questions is no more than 3 weeks old because it is updated every three weeks during one week of Monthly Close.
Stand by while I write Part 2: Designing Integrated Financial and Operational Data Tables…
[1] Common and obvious time wasters: beware of month confusion and always label files for month being closed not the month in which they were created. For example, as of January 31, 2021, it’s time to close January. That work starts on February 1, 2021 and takes until February 10–15th. We usually name and date files for the month in which they were created, but for close docs always use the month for which they were prepared. The January narrative is filed under a “January 2021” folder not February 2021. Think about what someone will be looking for two years from now.
[2] The risk for the Finance department isn’t that people won’t appreciate the January close doc on February 17th, it is that it will be operationally ignored or management will ask for them to be updated, adding more days to the Monthly Close process.
[3] This is why Amazon insisted on all accounting to be automated and written into software. When I was at Twitch, every software program dealing with money (I ran the Commerce team, so all of our features and products dealt with money), required sign-off from the central accounting team that we had written proper automated accounting into the application. Basically, they didn’t want any humans involved in tracking transactions and posting them appropriately to the GL. This was a smart move because it reduced human error, reduced human cost in making and then double-checking manual processes, and sped up the close process so that management could get accurate financial views of the business faster. From a financial point of view, those are all very important and worth slowing developers down a week or two here and there to write the automated accounting code.
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