August 3rd, 2023
With costs rising daily, it’s more important than ever for asset-intensive organizations to make the best use of their monetary resources. This means capital must be allocated to favor the initiatives that bolster the goals of the business as a whole. Additionally, since all potential initiatives have varying impacts on business growth or strategy realization, the monetary support those initiatives receive should mirror how well they support strategic business goals.
But how should an organization determine which projects are worth investing in?
How should they decipher which of those initiatives support business goals better than others?
And, depending on that information, how much capital should be allocated to each initiative so that your portfolio is optimized while also ensuring resources are used strategically?
In an article by McKinsey & Company titled “Capital allocation starts with governance—and should be led by the CEO,” authors Aaron De Smet and Tim Koller argue that achieving successful capital allocation is dependent on implementing a standardized decision-making process. They advise that the capital allocation process should be championed by the CEO and that it achieves the greatest impact when it’s marked by:
- A significant investment of CEO time
- The assembly of an effective “investment committee”
- A shift in leadership’s mission from gatekeeper to growth champion
- Getting clear and granular about resource allocation
- And the empowerment of a capable and influential support team
While we agree with these points, we believe that the process will fail unless it is supported by a consistent digital process that enables the best decision making. Let’s not get ahead of ourselves, though. Before we dive into our reasoning behind that belief, let’s briefly explore McKinsey’s steps to achieving a more impactful decision-making process around capital allocation.
A significant investment of CEO time
In the article, it’s stated that CEOs should have the final say over how resources are distributed. To make the best decision, CEOs must set aside at least 20% of their time per week to review the performance status of ongoing initiatives. As a result, CEOs can use their knowledge to constantly reallocate capital to more advantageous initiatives. McKinsey argues that “even the boldest decisions on capital allocation should not be ‘one and done.’ Instead, the CEO can ensure that key strategic initiatives are followed through in regular reviews.” This level of CEO involvement ensures capital is constantly flowing to initiatives that support the most positive business outcomes, supporting further business growth.
The assembly of an effective “investment committee”
Although CEOs have the final say regarding capital allocation, important decisions cannot be made alone. McKinsey writes “companies that are most effective at capital allocation vet their decisions through a committee.” As the CEO elects committee members, they should keep the following in mind: Members should be selected from the company’s most senior leaders to ensure the committee retains an enterprise-wide perspective. One of the committee seats should be saved for the CFO given the financial nature of committee discussions. Committee size should be limited to ensure voices are heard. Finally, as the CEO leads investment committee meetings, they must consistently encourage the committee to retain an organization-wide mindset, which is needed to make effective allocation decisions that benefit the company as a whole.
A shift in leadership’s mission from gatekeeper to growth champion
Traditionally, a company’s most senior leaders have worked to safeguard resources, acting as resource gatekeepers of sorts. While this is understandable, McKinsey calls this approach growth-destroying and urges CEOs to encourage teams to instead become growth champions. To do this, the CEO must ask company leaders to “relentlessly seek out opportunities for value creation” and ensure that the most successful initiatives receive the capital they need, at every stage, to support continued positive outcomes. Because capital allocation is ever-changing, regular investment committee sessions can be supplemented by the CEO meeting with the CFO and the head of FP&A (financial planning and analysis) to allow needed decisions to be made quickly in the interim.
Getting clear and granular about resource allocation
For organizational leaders to make the right decisions, they must first be clear regarding enterprise-level, strategic priorities. In short, what are the overall goals for the business? To answer this, McKinsey states leaders must understand the separate divisions within their business at the right level of granularity – not quite a 30k ft view but not quite a microscopic view either. The article advises business leaders to rank 10 to 30 of the most important initiatives within their organization and ask, “what do each of these initiatives need to succeed?” Then, weigh the probability of success if given sufficient funds. This prevents businesses from spending their resources on supporting the initiatives that have performed well in the past or on initiatives that might be phasing out due to poor performance. Instead, this granular analysis of each of the top initiatives allows capital to be allocated in ways that “align with strategic, forward-looking corporate priorities.”
The empowerment of a capable and influential support team
Speaking of granularity, just as the CEO needs the help of his investment committee members to understand the needs of the enterprise in relation to capital allocation, so too do committee members need feedback from their subordinates. Each support team should represent the different divisions within the business and should “help set the decision agenda, keep the decisions on track, and get the decision makers the most insightful, nonbiased, and actionable information,” McKinsey states. Support team members are invaluable in that they analyze capital allocation requests to present supporting data that will best inform investment committee discussion and, subsequently, the CEO’s decision-making process.
Digitalization: The missing link
We agree with McKinsey that implementing the five practices summarized above is vital for organizations if they want to make the most of their resources. However, we at Hexagon know that these practices will not make the most impact unless they are supported through digitalization. So, we’re adding a sixth practice to the list:
The CEO champions digital transformation of the capital allocation process
Digital transformation (or digitalization) is an ongoing process that includes the adoption and implementation of digital technologies by an organization to modernize existing operations, making them more efficient and successful, as a result. Digital transformation of an organization’s capital allocation process provides the mission-critical support needed for each of the original five practices to make the most impact. This is because digitalization ensures enhanced enterprise-wide visibility of all initiatives and allows for the standardization of the capital allocation process across the organization.
The benefit of enterprise-wide visibility
Enterprise-wide visibility empowers the capital allocation process in that decision-makers can see every piece of relevant data – from investment opportunities, to capital budgets, to project scoring and business cases. Digitally transforming your capital allocation process ensures that you’re utilizing modern technologies to house capital- and other project-related data points in one location that supports near real-time access to said data. Due to this, support team members are given the tools needed to relay accurate information to investment committee members and the CEO, in a timely manner. As a result, business leaders gain a clearer understanding of each initiatives’ potential performance, how capital is being leveraged and where capital may serve a greater use. Due to this, the CEO makes more effective and informed decisions, enabling quicker pivots while minimizing resource waste.
The benefit of standardized processes
Digital transformation of your capital allocation process ensures it becomes standardized across your organization. This means that no matter the division or initiative, every person involved in the investment committee or support team operates from the same capital allocation process. Digital transformation supports standardization in that it enforces all within the organization to work off of the same technologies, which can be customized to accommodate the specific steps of the capital allocation process. This means everyone within the organization is on the same page operationally as they evaluate spend options, create business cases and conduct stage gating since all of this is standard throughout the organization. As a result, when the CEO receives capital-related information, it will be relayed in the same way, every time, regardless of where the information originated. This instills a level of trust in the provided data and allows the CEO to quickly analyze the information and form a conclusion, without reorienting to differences in reporting.
Digitally transforming your capital allocation process: Where to begin?
Ensuring your capital allocation process is supported by today’s best technologies isn’t easy. There are so many technologies to choose from and they all seem to keep capital-related information siloed. So, how can you ensure the digitalization you implement within your organization is enabling your capital allocation process to make the most impact and drive better decision-making?
To best realize the capital allocation process prescribed by McKinsey, you need a completely connected project portfolio ecosystem that enforces best-practice workflows and maintains consistent data visibility throughout the funding and project lifecycle. To achieve this level of connectivity, industry leaders are turning toward Hexagon’s enterprise project performance solution, EcoSys™. EcoSys brings together project portfolio management, project controls and project management software all in one platform. This consolidation of all idea and project-related data into a single location allows project champions and teams, investment committee members and the CEO to easily access mission-critical information at every phase of the project and/or asset lifecycle.
This provides the enterprise-wide visibility and process standardization needed to support a more impactful capital allocation process as described by McKinsey & Company. The same portfolio information is then the same, integrated data as it becomes an actual project and ultimately an asset delivering revenue or strategic outcomes. As a result, organizations are best equipped to pivot monetary resources to high-value initiatives, resulting in maximized performance and profit as performance is visible and corrections more easily actioned.
Ready to learn more about how EcoSys can support the capital allocation practices referenced above? Request a consultation today to explore the possibilities.