By Bryan Lapidus, FP&A
A critical component of FP&A’s job description is decision support around investments, partnerships, and other initiatives. We study the financial impact, strategic alignment, and operational synergies to select projects that will help achieve the goals of the enterprise, and projects that do not add value are de-prioritized. After all our study and research, some initiatives will not work out.
That’s okay. And, increasingly, management thinks so too.
The view of project failures in the corporate world is changing, driven by numerous forces. The move towards a service and digital economy means that companies often can start and test ideas using relatively less capital than in previous generations, improving the risk/return calculation for experimentation. In manufacturing, advances like three-dimensional printing and computer aided design shorten the time and reduce the cost of testing. The advent of big data provides more information that can be mined or simulated. And there are cultural changes as well that encourage risk taking and accept failure as a necessary step. In Silicon Valley, there’s a saying: "You can’t get funding for a new venture without at least one good failure." Increasingly, CFOs are thinking like venture capitalists in evaluating their business opportunities—there need to be some failures on the path to big successes.
The implication for FP&A, and our organizations overall, is that we need to know how to handle failure as a routine part of our business. So how should we plan for failure? Here is a guide to get started.
A portfolio approach is perhaps the best way to guide FP&A’s thinking about failure—in other words, separate “committed” and “experimental” capital spend; what must give a positive return versus what is in the experimentation side.
The nature of being in business is accepting risk. Companies take and generate capital, then allocate that capital to satisfy a market need. In finance, we call this risk capital for a reason. There is the danger that we do not execute on our plans for any number of reasons: a competitor out-maneuvers us, customers choose a different solution, our pricing is wrong, our quality or service is poor, we cannot deliver to market, or regulations change. The danger of failure is part of the equation. Given how much easier it is to test ideas today, the danger is less but the opportunity remains greater. Therefore, we should be testing more often.
It is important to understand your company’s risk appetite for its investments and then project that onto the portfolio of opportunities. A portfolio approach allows for a diversity of investments that pursue different goals of the enterprise. Some investments are not allowed to miss—for example, implementing an e-commerce platform or building a deep-water oil drilling platform. A different section of the portfolio may be allowed to be more speculative, a chance to experiment, take risks and push the envelope of capabilities. FP&A should separate these two buckets and apply different standards of evaluation. The goal is that the overall portfolio returns acceptable financial and operational goals. Venture capital often works this way; two in 10 investments may hit, but that means the other eight fail.
One way to pursue projects is a top -down, centralized approach where an opportunity is studied by experts and researched, then a plan is formed and executed. An alternative approach is to pursue many paths simultaneously and see which yields the best results.
For example, a global manufacturer of consumer goods wanted to build a new sprayer to improve their detergent manufacturing. They began with the top-down approach and studied the fluid dynamics and built prototypes but could not design an effective tool. Then they pursued an iterative process. They built 10 different nozzles and chose the one that worked best. They then made 10 iterations of that winner and chose the best performing one from that set. They continued this through 45 generations. They admit that they are not sure why it works, but are pleased with the outcome.
For FP&A, a strategy of multiple small bets will entail many failures in pursuit of success. In creating this business case, it is best to bundle all the bets into a single expense and evaluate the project in its entirety.
The philosophy of agile software development has become embedded in many different areas: build a component, get immediate client feedback (testing), adjust and move on to the next sprint or work segment. This can be a guide for FP&A as well. Rather than committing capital in large blocks, assess projects at multiple stages to determine whether the investment is proceeding as it should. What adjustments should be made? Should we continue with the project? Management guru Tom Peters had a mantra for this feedback loop: “Test fast, fail fast, adjust fast.” Finance can adopt this outlook as well.
“It is important to distinguish between productive and unproductive failures,” said Amy Edmondson, an economist and professor at Harvard Business School. “Simply embracing failure would be as silly as ignoring it.” Investments need to yield something of value for the organization, whether that is financial, understanding, or other insight. The investment process can ensure this education by documenting what was learned during all projects, successful or not. For failures, these learnings are even more valuable so that you can recoup something from your investment.
To do this, all projects require a post-mortem analysis or after-action review to gather learnings and improve organizational efficiencies. Going a step further, when building the business case, include a section about what the expected business learnings would be in the event of failure. Think of it as estimating the salvage value to an asset, or de-risking the investment.
Perhaps my Little League baseball coach put it best: “If you’re not getting dirty, you’re not trying.” Of course, it is easier to say that failures are a part of the game, and that it is permissible to simply end a project and move on to the next one. The truth is that the typical corporate culture sees failure as a potential career-limiting event that can tarnish your reputation.
To change this culture and allow failure requires leaders to publicly embrace the ethos that failure is a necessary partner to success. One division president lauded a team who determined that their project would not work and terminated the effort. He brought the team up on stage at a town hall meeting and said, “They completed their project. It failed to produce what they expected. But congratulations, we are giving you a bonus, sending you on vacation, and will give you a new project when you get back.”
In other words, failure is acceptable, even desirable, when the work is good and knowledge is gained. To continue with a project once you realize it will not produce desired outcomes? That would truly be a failure.