McKinsey recently published a survey about whether CFO’s are ready for tomorrow’s demands on finance. For the most part it is not terribly helpful. The additional roles include the “new” fields of risk management and compliance. These tasks have been with us for decades, but today there is a department with the title. My experience with big consulting firms is that they offer good input at a high price. (However, I read everything Tim Koller writes for McKinsey and you should too. I’d classify his insights as great ideas.)
The CFO survey had one question about capital expenditures which caught my attention. Only 30% of the CFO’s agreed that their company “has a formal process to review investments made 3-5 years ago.” This is a big problem as firms that don’t check on their performance don’t learn from their mistakes. Retrospection is hard and I get why you don’t want to do it. Ben Franklin said “Experience keeps a dear school, but fools will learn in no other”. When a management team makes a mistake and doesn’t learn from it then we even less smart than the fools.
I know that everyone cares about the stock price. Stock prices are driven by the return on investment in the projects the management team selects. Poor project selection means poor investment returns and poor stock price performance. Measuring returns informs future investments and identifies opportunities. It creates accountability. It is the difference between taking a class in investing and trading in the stock market for a living. Great investors track their wins and losses and try to learn from both, although the losses are always the most informative.
After being a CFO I took a turn as a hedge fund analyst. About 10 years ago I went to a stock presentation where Coldwater Creek was touting their secondary offering. The plan was to open new units that would generate great returns, earnings and a high stock price. The management team offered up very compelling ROI’s over their first three years of investment in a new unit. I got to ask one question: “how many of these stores have reached their three year anniversary and did they perform similarly to the forecast?” The answer was they had no units that had yet reached the three year life. I wanted a follow up question but the CEO wisely picked on another analyst. Simply put a pro-forma financial model is not the same as actual results. Coldwater Creek never achieved those planned returns and the $32 stock is now worth 2¢.
I worked with a major US bank and was told that the way to promotion was to make a lot of loans fast. When inquired about what happens when they inevitably go bad, I was told that the rotations typically lasted 24 months, and the problems didn’t show up until after you’d left the department. Credit problems were never tracked back to the initial bank officer, just assigned to the executive that then held the portfolio. The difficult job at the bank was in following one of these “fast-trackers” and constantly dealing with a crappy portfolio. This strategy worked until there was a slow down in growth and executives were stuck in the job for 48 months. As Warren Buffett says “ Only when the tide goes out do you discover who’s been swimming naked”.
Recently I heard that the average Silicon Valley CFO lasts 28 months in a job. I’ve never seen a financial analysis on a public company that didn’t go back at least three years if the data is available. The analysis usually go back at least five years and I’ve seen some that go back ten years. We do that to get a sense of how capital has been deployed though the firm’s history. I’ve written here about how hard it is for senior executives to change a business model. Returns on investment are persistent with companies generally moving towards the mean return for the industry. Some of reversion is due to luck evening out, and some of the reversion is due to management teams responding to incentives, both bad and good. If the management team knows that they will be held accountable for capital investments, they have a big incentive to do a better job.
I get that everyone wants to focus on the future and no one wants to poke through past errors. As investors, we are relying on CEO’s and CFO’s to invest the assets of the company wisely. As executives, that means taking a hard look at how capital has been invested, what we did wrong, what we did right and what that teaches us.
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Dr. John Zott is the CFO for Carlson Wireless Technologies, and Principal consultant at Bates Creek Consulting. John is the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University and comments regularly on issues that affect consumer businesses. If you are a former student, colleague or would just like to connect – reach out.