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We need to talk. Before management reporting can work as it should – as a jumping off point for real conversations about the business – companies should ...

We need to talk. Before management reporting can work as it should – as a jumping off point for real conversations about the business – companies should break some bad habits.

Did your last financial results meeting go something like this? Two weeks ago, the new product hit the grocery shelves, albeit a bit late and to disappointing results. What went wrong? Sales say they made their revenue numbers, but with its slotting fees and chargebacks marketing tells a different story. Production blames supply chain for not providing enough raw materials; supply chain reports insufficient lead time to meet a revised forecast from sales. Logistics expects a lot of returns because of quality problems, but QA doesn’t mention any outstanding issues. After a few hours, nothing’s resolved. It’s surprising how many CFOs of consumer products companies do not get the reports they need to solve problems and make more effective decisions. They certainly get a lot of reports, many fat and bristling with statistics; but often these turn out to be full of facts, short on insights. Perhaps most deadly to the perspective the CFO wants is the “silo” approach to reporting, where each function tallies up its own debits and credits without anyone providing a moderating view of the big picture. But the whole is greater than (or at least different from) the parts, and it’s the whole that matters.

How could management reporting be improved to make it a true exchange of valuable information? In many consumer products companies, the answer is found not in the reports themselves but in the practices and processes surrounding the reporting process — in other words, in corporate and individual behavior. Getting the conversation on track Management reporting should focus on the trends that affect performance (whether that’s measured in sales, margins, revenue, production volume, on-time delivery, or any other appropriate and important metric) and on the business drivers that affect value creation (as defined by strategies and objectives). In doing that, reports would answer these questions: “How did we do? What did we do right or wrong? Where and why did we fail to perform to plan? What does the future look like? How can we affect that?” Getting that kind of reporting quality can start with these five steps.

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1. Set a good example Many times, the complexity in today’s reporting — when reports are too many, too long, too detailed, and too broad in their scope — comes directly from the leader’s own management style. For example, if a CEO says one thing but does another, management teams will sometimes over-report to cover most possibilities. Or if a leader confuses chaos with creativity, managers may have no choice but to pile on detailed reports. Here are a few other, common potential scenarios: • When CEOs or CFOs don’t trust the quality of information they’re getting, they’ll keep asking for more reports. Or when managing executives don’t have a shared understanding of the performance objectives of the business (or of their role in achieving those objectives), they’ll produce more reports to justify their focus and performance. • Executives who “manage to reports” instead of “managing to value” encourage the generation and churn of huge amounts of information; but this information is not necessarily relevant. • In companies where people work in silos, or where business units and departments have to compete for attention, management reports tend to focus on a narrow set of activities without “connecting the dots” to other areas. The CFO can see the trees, but not the forest. • Sometimes, a CEO or CFO will ask for a lot of ad hoc reports, which then continue to get produced long past the occasion that prompted them. The CEO and CFO should set the tone for more effective reporting with their own behavior— by measuring the right stuff, rewarding the desired behavior, establishing clear lines of accountability, and communicating values and responsibilities.

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Effective practice: A good rule of thumb is to encourage reporting that’s directionally correct instead of precise and overly detailed. Of course, that’s possible only if accountability is aligned with responsibility and if cross-functional collaboration is rewarded.

A new conversation Once a week, the VP of operations in a consumer products company reviewed sales and volume in a meeting that included the leaders of each business function and their finance staff — more than 70 attendees! In fact, he liked that the meetings were “events,” that the agenda each week was “open,” and that presentations and conversations during the meetings were random and aggressive. Then, in a cost saving initiative, the CFO rationalized the company’s management reporting practices. Everything changed — for the better. When each management report had to address a critical metric, the number and lengths of reports dropped dramatically. The VP’s meetings included only four key people; its topics were limited and relevant, as attendees were expected to come up with an action plan for closing any gaps between past performance and growth targets.

2. Measure the right stuff If a company has the wrong key performance indicators (KPIs), it will most likely get the wrong behavior. All the dashboards, spreadsheets, and reports imaginable won’t move the business one step closer to its objectives unless the measurement system encourages behavior that adds value. When KPIs are wrong or missing, meetings to solve big problems end in requests for more information; analysts spend dozens of hours preparing reports for the next iteration, only to find that the ground once again shifts beneath their feet.

Getting the right KPIs in place starts with an understanding of value drivers (and it’s surprising how many leaders don’t know what these are for their businesses). Then, activities not contributing to value can be identified and cancelled. With the right KPIs, the CEO or CFO can determine a shared understanding of what should be done and who should do it. (Of course, as business objectives change, so should KPIs; managing behavior is a constant and continuous process.) An effective performance management system should align the goals of the company and the behavior of employees. Such a system has three components (Figure 1): • Planning (where do you want to be?) • Monitoring (how are you doing against objectives?) • Improving (how can you change behavior to achieve more effective results?) Figure 1 Align the business to delivery on strategy • Set strategy at the executive level • Communicate throughout the organization • Determine KPIs to drive strategy

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Active intervention to realign the business • Create an incentive structure to represent and reward the desired behavior • Encourage broad dialogues about performance

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Run the business and monitor performance • Develop management reporting processes to highlight KPIs • Establish clear performance standards • Assign accountability of metrics

Of these, it’s the third component that is most often lacking, as companies have plenty of performance information, but not much insight about what should get done or be changed. The relevant KPIs close the gap between strategy and execution by redirecting everyone to focus on the desirable behavior. Finally, the effective KPIs can allow a company to industrialize the gathering and compiling of data. When processes and systems are in sync, and when the required data is captured at the correct time, analysts can be free for value-add, strategic activities. What’s required are 1) an infrastructure that’s flexible enough to keep up with changing demand and evolving business models and 2) a data governance model that can maintain business definitions and protect data integrity. Effective practice: A good system of measurement should balance complementary KPIs — effective versus lagging, financial versus non-financial, corporate versus business unit, strategic versus operational information, output versus process — to help make the management reporting process dynamic and action-oriented.

What’s the score? A consumer products company reorganized its business units to align with a new market strategy. In the process, management realized that the KPIs were not consistent with the new strategy. To execute against the new strategy, the company’s leaders needed to redefine KPIs across the business and institute a balanced number of new metrics using a blend of leading and lagging indicators. Achieving the desired results in this effort depended on getting business unit buy-in and organizational agreement, including an understanding of why the metrics had to change and a “business case” for the new KPIs based on cross-organizational analyses. Now, with the new metrics, management can view, understand, and act on KPIs, thereby monitoring and supporting the company’s progress against its new market strategy objectives.

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3. Reward the desired behavior Incentives and compensation drive people to perform well. Employees want to affect results and then, ultimately, get recognized for their actions. (One caveat: the applicable metrics have to be in place, as discussed in step 2). Then, why do companies so often try to establish an integrated framework for managing performance without addressing incentives? Employees will likely resist new KPIs (or old ones, for that matter) if their behavior doesn’t seem to have any tangible effects. When KPIs are set — or changed — incentives should be evaluated. This is where executive leadership comes into play. Too often, incentive structures are thought of as an HR responsibility. But to achieve the desired behavior from the organization, a CEO or CFO should decide on a compensation system based on metrics that are aligned with strategy. While HR can have a role in designing and administrating an appropriate and effective structure, the sponsorship for any compensation philosophy should come from the top. Effective practices: 1) When new KPIs are introduced to the organization, management should use a “phase in” period to allow employees time to understand the new expectations for their performance. Only after that adjustment period should compensation and incentive structures change. 2) Many components of a reward system — including pay, bonuses, benefits, and recognition — should be aligned.

Walking the talk A consumer products company recently reviewed and revised its “future state” vision and long-term strategic plan. Along with this change, the executives evaluated and established a new set of metrics to define effectiveness in the marketplace. When introducing the new metrics, the company gave the employees one year to absorb and adopt the changes. After that, new incentives were introduced to enforce new behavior. By giving employees time to adjust, the company achieved a more effective adoption of new behavior.

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The bad consequences of good intentions Sure, I lowball forecasts, but what’s the harm? I hit my targets every month. A consumer products company set a growth target of 12 percent, but rewarded managers against forecasts without considering emerging trends. Unintended consequence: Being measured by forecast accuracy encouraged low expectations and under-delivery. Employees are compensated for output, period. A food provider company had a higher-than-average number of food safety recalls. Quality was a strategic priority; but operations management was measuring on gross margin and inventory metrics. Unintended consequence: By the time a recall impacted long-term profitability targets, operations management had already been rewarded for hitting short-term numbers. I’m compensated for my sales; so there’s no upside to working together. In a consumer products company, multiple sales teams served the same customers. But because the company measured employees by what they directly controlled on their profit and loss (P&L) statements, each team lacked visibility of others’ effects on its customers. Unintended consequence: Customers didn’t see a single face of the company, and multiple touch points were confusing; competitors gained an opportunity to steal market share.

4. Establish clear lines of accountability If everyone is in charge of everything, no one is in charge of anything. If everyone is held accountable for everything, no one is accountable for anything. These paradoxes trip up companies that think they’re doing the right thing in making everyone answer to each core KPI. Fundamental to effective performance management is balancing individual behavior and accountability with objectives for the whole enterprise. When assigning accountability, executive leaders should evaluate and decompose major KPIs into their basic building blocks, thereby gaining an understanding of the true responsibilities of each function and each role with the organization. Once responsibility is assigned, employees should be educated on how they can directly affect outcomes, as well as how their outcomes (plus the outcomes of other areas) contribute to overall enterprise performance. People who cannot affect an outcome (say, gross margin) should not be held accountable. Incentives should follow responsibility. Effective practice: 1) Incentives should match accountability. 2) Collaboration across departments, functions, and business units creates the high-quality state where the whole is greater than the sum of the parts.

A win/win environment In a consumer products company, one employee has a customer-facing job of managing sales, while another is responsible for production and distribution. The sales employee establishes and optimizes product prices, while her colleague manages costs in the manufacturing process. While the sales employee cannot directly impact these costs, variations in commodities (inputs) can have a significant effect on margin, which in turn can indirectly affect prices. The sales employee works with the production and distribution to understand supply chain trends and fluctuation, so she can take these into account in setting prices. Overall gross margin can improve. At the same time, production can gain an understanding of price setting and should be motivated to think about how to improve purchasing practices and productivity. Collaboration allows both employees to do a more effective job in the areas over which they have true control. But it can also allow them to influence and inform each other’s performance, thus creating value beyond their immediate scope of responsibility.

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5. Communicate values and responsibilities New behavior begins with understanding. Effective communication is a challenge for companies of varying sizes. Incentives and accountability may be perfectly aligned and executives may be leading by example, but people may still not be behaving in a way that is desired to achieve the company’s strategic objectives. What could be the reason? Employees may not know either the company’s values or the individual’s role in expressing those values in his or her work. Sometimes, the problem is simply insufficient or inconsistent communication. Shared identity tools and diagnostics can be used to assess whether the employee’s values and vision are aligned with the organization and to understand what other factors could be incorporated to motivate employees. Effective practice: Change management should not be an afterthought. Instead, change management should be discussed and planned for upfront, in parallel to any initiative that will change how people work, so that proper communications can take place. Recurring and meaningful communications that discuss changes in terms of impact (What’s in it for me?) help set expectations appropriately.

Finding the agents of change A retail company wanted to implement a strategic vision to “win the sale” and get the organization on board, as one unified enterprise, across each channel. This strategy was a shift from its then-current model in which sales were made and measured within a channel (or silo, in effect). KPIs were reviewed and revised to give employees credit for a sale regardless of which channel the customer used. But the new wasn’t “sticking” because it was not executed correctly; employees were comfortable with the way they’d normally worked and the KPIs were not being enforced. The CFO decided to run a diagnostic to see whether stakeholders understood and shared the CEO’s vision. As a result, two things became apparent: 1) those resisting the change were concerned for their own professional development and overall relevance to the company under the new model and 2) those supporting the change could be enlisted to promote it effectively throughout the organization. With an understanding of people’s motives, the CFO was able to refine the KPIs, making them even more powerful tools of positive change.

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The bad consequences of good intentions, cont. As a good steward of financial assets, I allocate every fixed cost. A consumer products company wanted a fully burdened P&L — not just to direct economic decisions (e.g., about pricing or return on investment (ROI) on marketing) but also to be viewed as part of the monthly management P&L. But no one understood the allocation, and everyone resented being held accountable for costs they couldn’t influence or control. The numbers were ignored or fiercely battled. Also, since Selling, General & Administrative (SG&A) expenses were allocated across the organization, the company lost sight of the fact that its SG&A-torevenue ratios are among the worst in the industry. Unintended Consequences: 1) Time that could have been spent on analysis and strategy development was wasted on developing, maintaining, and explaining complex allocation models. 2) By hiding the inefficiencies in the support functions, the company missed an opportunity to streamline its cost structure and become more competitive in the marketplace.

Imagine this. Now, your management meeting goes like this.

Contacts For more information:

We know why the product performed poorly:

Tom Bendert Principal Finance Practice Leader, Consumer Products Deloitte Consulting LLP +1 212 618 4222 [email protected]

First, incentives for the launch focused on ‘on time’ delivery, not on any likely impacts on contribution margin or market penetration. So, the product was rushed to market before it was ready. Second, the sales team was late in sending forecasts, so operations did not have enough lead time to order the raw materials. Finally, an analysis of the ROI of the marketing investment shows that print ads would have been a more effective medium for marketing this product. With a new integrated reporting tool, we’ll realign metrics to promote shared accountability. An understanding of significant variances (provided by analysts) can drive action plans. And we’ll use marketing’s insights about revenue trend by product and by region to design more appropriate marketing campaigns and sales support. A new contribution-margin-by-customer report shows some of our customers are not as profitable as we thought. So, we need a new incentive structure that will reward business unit managers for year-over-year growth in customer contribution margin.

Elaine Liao Senior Manager Finance Practice Deloitte Consulting LLP +1 703 251 1195 [email protected] Visit Deloitte.com To learn more about our Consumer Products Industry practice and our capabilities within the area of planning, budgeting, and forecasting (PBF), visit us online at www.deloitte.com/us/consumerproducts.

In this meeting, the conversation focuses on variances, key business drivers, and future decisions and plans — those management behaviors that can create more value. That’s management reporting the way it should be.

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This publication contains general information only and is based on the experiences and research of Deloitte practitioners. Deloitte is not, by means of this publication, rendering business, financial, investment, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this publication. As used in this document, “Deloitte” means Deloitte Consulting LLP and Deloitte & Touche LLP, which are separate subsidiaries of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Copyright © 2012 Deloitte Development LLC, All rights reserved. Member of Deloitte Touche Tohmatsu Limited 8

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