Why Strategy and Finance Go Together

A sound business strategy depends on three factors:  beating the market, sustaining profitable growth, and generating the financial performance needed by the firm.  This article discusses how strategy and finance work together to achieve these objectives.

 

THE FINANCIAL MEASURES OF STRATEGY

Business strategy is about making a particular business the best in its market.  The objective is to serve customers profitably and better than the competition over the next 3 to 5 years.  This requirement means building competitive advantage as a mean to provide sustainable and profitable business growth, and fend off competition at the same time.  Therefore, strategy must be grounded on measures of market performance, including customers and competitors.  It must also include measures of financial performance to achieve sustainable profitable growth.

The development of strategy typically involves four steps:

  • First is an analysis of the current situation of the business.
  • Second is the the formulation of strategy, a plan to serve customers profitably and beat the competition, by leveraging competitive advantage.
  • Third is the evaluation of potential strategic options that vary in scope, level of investment, and risk.
  • Fourth is the decision of which strategic option to pursue.

Each step is grounded on explicit financial measures, which make the strategy specific, measurable, and results oriented (Figure 1).

Fig. 1 Financial Measures of Strategy

 

WHAT COUNTS IS NOT ALWAYS COUNTED

However, strategy is more than financial performance as it concerns market performance as well.  Sound strategy drives value creation by building competitive advantage, which is not reflected in financial measures.  Market share, pricing power, share of distribution, relative cost position, sales force effectiveness, uniqueness of technology, supply chain effectiveness, operational effectiveness, operational efficiencies – these are examples of drivers of competitive position and sources of value that a financial test will miss.

A financial test determines the merit of an investment based on its financial performance, but it doesn’t address where the investment will position the firm vis-a-vis the competition or the sustainability of the company’s market position.

As a result of using solely financial tests, in time companies may find themselves in a strong financial position, but inevitably in a weak strategic position.  Typical signals of a weak strategic position include market share erosion, customer defections, price deterioration, stagnant growth, lack of future growth opportunities, unfavorable relative cost position, disproportionate increase in the cost structure, low-turning assets, lack of advantage, inability to defend against the competition, and overall loss of business value.

 

HOW STRATEGY AND FINANCE WORK TOGETHER

The roles of strategy and finance come into focus over decisions of resource allocation.  Initiatives such as Investing in new products, expanding into new markets, cutting unproductive business lines, rationalizing production overcapacity, M&A deals, divestments, and strategic alliances are just some of the investments that require hard decisions.

Strategic investments need to pass four tests to be effective, including the following:

  1. Does the investment leverage and build the company’s competitive advantage?
  2. How does it improve the firm’s competitive position?
  3. How much value will the investment create?
  4. Will it deliver the financial performance needed?

 

Fig. 2 Tests for Strategic Investments

 

WHAT COMPANIES STAND TO GAIN

In the best organizations, the strategy and finance functions work together in executing these tests, as each provides valuable expertise.   The precision established by the tests improves the quality of information and the soundness of the investment decision.   Some of the benefits include the following:

  • Shifting from a mind set of short-term financial efficiency to sustainable value creation for the future
  • Connecting business strategy, value creation, and financial performance
  • The ability to act on the drivers of competitive performance
  • The ability to evaluate strategic investments objectively and thoroughly from both angles, strategic and financial – a competence particularly important for costly initiatives such as M&A deals, divestments, and strategic alliances, but also for organic  growth initiatives, cost reduction programs, and asset restructuring
  • Greater depth and transparency of analysis, which drive better decision making and greater confidence in the decisions being made
  • The ability to explain the business strategy, corresponding investments, and value openly and precisely to various stakeholders, including the board, executive management, shareholders, partners, and investors.

As a result, companies where strategy and finance work together improve their odds of successful strategies and superior financial returns.

To learn more, get our publication:  “Business Strategy Formulation:  Uncover The Greatest Potential To Add Value.”
To learn more about our practice, go to Strategy & Finance.