The following article appeared in the CFO Journal in the WSJ on Monday, July 28th, 2014.
If the future for all businesses is digital, as many say, the real question for CFOs is, what does this mean to the future of finance? According to research from OpenMatters, with analysis by Deloitte, CFOs need to go digital or face putting their company’s future at risk.
Years ago, companies with physical assets could count on having a balance sheet that was approximately equal to their company’s market value. At that time, CFOs could generally provide an accurate accounting to the board and shareholders of the organization’s value-creating assets. This historic method of value creation and reporting is less valid in today’s digital world in which tangible assets, including plant, property, equipment and financial assets, now constitute 20% or less of total corporate value.¹
In short, digital technologies are increasingly disrupting age-old sources of value. And CFOs who do not embrace digital technologies could be creating strategic and operating risks for themselves, their company management and their board and shareholders.
Moreover, research by OpenMatters, with input from Deloitte & Touche LLP, shows that companies whose CFOs continue to allocate their company’s capital to tangible assets using previous generations of technology could generate lower levels of performance and enterprise value than digitally and big-data savvy CFOs who are spending their organization’s resources on building and mining intangible assets powered by today’s technologies. Further, CFOs who lack an understanding of digital and big data might over-invest in hard assets because that’s what they measure, track and report, while under-investing in intangible assets. These intangible assets include people, such as customers, employees and investors, as well as intellectual property, and social and business networks. In addition, those same CFOs, who may lack technology-specific knowledge and experience, are not likely to approve the necessary expenditures for new technologies—Cloud, Analytics, Social, Internet of Everything and Mobile, or collectively referred to as CASIM—that power these new types of intangible assets.
Software—and the social and mobile networks of crowds that software powers—are “eating the world,” in the words of Mark Andreessen, Internet entrepreneur and venture capitalist.² The reason is clear: digital technologies and the social and commercial networks that software enables are transforming how customers interact, employees engage and investors invest. In response, companies in every industry are beginning to adopt and embed CASIM into how they operate, create, communicate and conduct commerce. Those that haven’t or won’t adopt them are playing a risky game. We can all think of once-great companies that have fallen to new, disruptive competitors in the past decade—from door-to-door encyclopedia companies, to traditional book retailers, to film-focused camera companies, to brick and mortar DVD retailers—and the list will continue to go on.
The research OpenMatters conducted of the S&P 500, in collaboration with Deloitte, shows that businesses at the forefront of today’s digital revolution are cashing in with consumers and investors who are following, if not driving, this transformation. Yet, many traditional businesses are still struggling to embrace the disruptive power of CASIM.
The good news is that virtually every CFO, regardless of industry, has the potential to improve their company’s shareholder value and current performance by allocating capital to digital technologies and the new types of assets that are creating value. What makes transformation hard, however, is that some of these newer assets have been inaccurately measured as expenses (e.g., employees), while others have been under-measured (e.g., brands and other intellectual property), and still others have not been measured at all (e.g., customers and their interactions) as assets. Achieving the benefits of these new assets requires a mental shift for many CFOs who were raised in a different era with what are now outdated rules for measurement, management, investing and reporting.
Business Models and the Mental Models That Drive Them
OpenMatters’ research on 40 years of data from the S&P 500 companies shows that almost every company fits into one of four business models, regardless of industry or function:
- Asset Builders: Companies that use capital to make, market, distribute and sell physical things. Examples include everything from automakers, to chemical manufacturers, big box retailers and distribution and delivery businesses.
- Service Providers: Companies that use capital to hire employees who produce billable hours or offer services for transaction fees. These companies are similar to Asset Builders, but depend on an individual’s output rather than a machine’s output. Examples include consulting firms and financial institutions.
- Technology Creators: Companies that use capital to develop and sell intellectual property such as software, analytics tools and intellectual property. Once created, these assets can be sold multiple times. Examples include software, big data tools and medical device companies.
- Network Orchestrators: Companies that use capital to create a network of peers in which every participant makes and sells products or provides digital content to the many other members of the network. Examples include online financial exchanges, social media businesses and credit card companies.
According to OpenMatters’ research and the Deloitte analysis of that research, investors pay premiums for Technology Creators. And the same holds true for Network Orchestrators (whether they are consumer or business focused), with investors valuing these two classes of business models between two and four times more than their Asset Builder or Service Provider counterparts. In fact, the average multiplier (or price to revenue ratio) is roughly 2x, 3x, 5x and 8x, respectively, for businesses that are Asset Builders, Service Providers, Technology Creators and Network Orchestrators.
The bottom line: The organizations that are most effective in delivering company performance and enterprise value are allocating their capital to growing business models that serve today’s empowered and digitally connected customers. And investors are rewarding their efforts.
If business models drive value, then what drives business models? The answer is, the “mental model” of a company’s CFO, his or her management team, and the board of directors. Mental models drive capital allocation, meaning people invest in what they believe has value. For example, leaders of asset builders believe that value resides in developing and owning (or leasing) hard assets, which can be used to manufacture, distribute and sell physical things. Leaders of Service Providers care about hiring people and selling services (including billable hours). Technology Creators focus on developing and selling intellectual property, such as medical technology and software. Network Orchestrators’ top priorities are building and operating social and commercial networks that foster interactions and co-creation with their customers.
Companies measure what they think matters and then invest in it. So a good way to understand where a company is headed—and how likely it is to embrace today’s digital revolution—is to look at what their financial reports measure and how management and the board use the data to make capital allocation decisions. For services company CFOs, the key measurement is the number of employees and their billable hours and productivity. For asset companies, it is the output from their facilities. On the other hand, digitally savvy CFOs measure and report the number of participants in their social and commercial networks, their interactions and product and service contributions, as well as the number of subscribers, seat licenses and monthly recurring revenues for each customer.
Spend Dollars at the Margin on More Valuable Revenue and Business Models
Among CFOs’ main responsibilities in serving shareholders is helping management prepare the annual budget, monitor and report progress against the budget and then recalibrate the following year’s budget based on the progress achieved. Given that each marginal dollar can be spent to generate revenues that are either valued at a multiplier of 2, 3, 5 or 8, CFOs have a responsibility to help improve their companies’ performance and valuation by allocating resources to building and developing their business or consumer networks and developing the appropriate metrics to measure the costs/benefits and report back to management and the board.
Build the Finance Function of the Future: Go Digital, Embrace Big Data and Create Value
How can CFOs help their boards and fellow leaders become more digitally savvy—and begin to alter their business models to add more value to the enterprise? Following are three recommendations to consider:
—Assess your own mental model and business model biases to determine what you and your finance team believe are the sources of value (and risk) and what you measure and report to your management team and board. Are you and your team focused on hard assets? People and services? Technology and research? Networks and relationships? What you measure and report on will reveal what you prioritize.
—Begin to rebalance your yearly budgets to reallocate capital to more valuable business models to create value where no value previously existed. This includes codifying your intellectual property, building and selling technology offerings where they did not previously exist, and building and developing robust networks comprised of your customers, prospects, partners and employees.
—Use big data in concert with financial data to constantly measure, monitor and report the results from these new initiatives. And use today’s real time social monitoring tools to track your constituents’ interactions and engagement. In time, look to have them co-create new products and services for your organization as you create deep and long-lasting relationships with them as network members.
As demonstrated by the business model research, the stakeholders CFOs serve are already reallocating their capital to digitally savvy Technology Creators and Network Orchestrators, and are paying premiums to invest in them. It’s time for all CFOs to make the quantum leap into the digital world and acknowledge that going digital and mastering big data are critical to capturing the significant value that is not currently reported in financial statements and investing in digital and big data for longer-term growth. It is time to begin this journey, or risk being left behind!
1. Ocean Tomo, 2010.
2. “Why Software Is Eating the World,” WSJ online, August 20, 2011.
—Written by Barry Libert, CEO of OpenMatters and a board member/senior fellow of the SEI Center at Wharton; William J. Ribaudo, a partner at Deloitte & Touche LLP and national industry leader for Technology, Media & Telecommunications; and Megan Beck Fenley, a digital consultant and researcher at OpenMatters.
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