Where, how much, and how: Answering the hardest questions of resource allocation
The
challenge of resource allocation is determining where the resources
will bring the most value, how much money and talent to
redistribute, and how to put those shifts effectively into
action.
I recently listened to a CEO client lament his
company’s low growth and the difficulty in shifting resources from a mature
business to new fast-growing ones. The challenge he faced is all too common:
unit presidents protective of legacy businesses, strenuously arguing that
reducing resources would endanger the company’s biggest cash cows. Would the
returns from investing in the new businesses justify this risk? And how much is
really needed to get those businesses onto the growth fast track?
These are essential
questions when trying to ensure that the organization’s money is working as
hard as it possibly can. As I pointed out in my last post, the problem with
resource allocation isn’t ignorance of its importance—83 percent of executives
we polled named it as the most critical management lever for spurring growth.
The challenge lies in determining where the resources will
bring the most value, how much money and talent to
redistribute, and how to put those shifts effectively into
action.
Those overarching
questions represent the three major phases of the reallocation process. Only by
answering them with empirical rigor will you be able to get your team on board
and embed the process into the organization.
1. Where to reallocate resources
The first step is to
create an analytical foundation on which you can build a strong case for
resource shifts. This is essential to overcome resistance from losing parties
and counter individual biases rooted in self-interest or mistaken assumptions.
To identify and prioritize areas where boosting investment would generate the
greatest impact for the whole organization, start by assessing the
profitability and resource projections for every meaningful business cell.
Managers tend to easily
identify the opportunities with the biggest growth upside, but as I explained
in an earlier LinkedIn post,
growth doesn’t guarantee value creation. To have a comprehensive view, you need
to understand projected economic profit (the difference between ROIC and the
company’s weighted average cost of capital) for each business cell or, in some
cases, build a full investment plan and calculate the net present value (NPV)
of future cash flows. Then compare that to the resources needed to deliver the
projected ROI.
This analysis will indicate that some
cells with high projected ROI are obvious candidates for acceleration. Others
may be actually destroying value, suggesting it’s time to reduce their resource
share or even exit the business entirely. In between are businesses with
positive but modest economic profit. A large organization may not need to
closely analyze every one of these mid-range performers but it should at least
look at ones that absorb a lot of resources. Are there better ways to optimize
their return on investment?
Now managers will realize this process
will influence their budgets, so they will be tempted to inflate their
projections or forecast stabilization after a period of decline. Accordingly,
any discussions of their proposed strategic plans should start with the
question: Why do you believe this improvement will happen?
The best way we overcome the “hockey
stick” pitfall is to create a baseline scenario based on objective data,
looking at a business’s performance track record and carrying that forward for
several years to develop a “momentum” case. Factoring in management assumptions
(where valid) and additional market and competitive insights can further refine
the scenario—which often ends up looking very different than the manager’s
initial view.
2. How
much resources to reallocate
Determining the right magnitude of action
is often harder than identifying the targets for it. The relationship between
investment and return is not linear, as capturing some opportunities requires a
major investment (in new IT systems, for example, or establishing a direct
sales force). Conversely, if you want to lower your capital investment, you may
still be stuck with some “maintenance” costs.
Managers want to know the return on the
marginal dollar but this non-linearity makes that impossible. In my experience,
a pragmatic alternative is to approach resource shifts differently depending on
whether they are candidates for increase or decrease.
For underresourced cells, ask yourself: Is
there additional market upside we’re not capturing? It may be that ROI is high
because you have a strong leadership position and to grow more you would have
to increase the overall market demand—which may be possible in some areas but
not in others. If there is upside, how much money and talent would you need to
apply to tap it? Is the business case still attractive when you’ve factored in
all the risks, such as a change in competitive dynamics or regulations? Would
it be better to boost resources dramatically to drive a higher level of return
or to be incremental? In some cases, gradual increases may suffice while other
opportunities require big bets to gain meaningful market share.
For overresourced cells, start by
analyzing what’s behind the low performance—is it an industry-wide issue or
your company’s problem? If your business is performing a lot worse than its
peers, you need to understand what is holding it back. In rare cases, you may
discover that the issue can be addressed by injecting more resources, with
potentially high rewards. More often, it’s a market problem or the company is
facing a structural competitive disadvantage. If so, it’s time to ask whether
lower investment levels would bring the unit to an acceptable ROI—and if not, consider
divestiture.
3. How
to execute resource reallocation
The fundamental goal of resource
reallocation is to embed agility in the organization so it can move as
opportunities shift. Many companies, however, face internal barriers, ranging
from business leaders seeking to protect their turf to resources being embedded
in ways that makes them hard to free up. For example, if you need to shift
R&D investment, the existing people may not be the right fit or the
facility may require an expensive relocation.
Here are some steps you can take to
overcome internal resistance and fear of change.
·
Clearly communicate to
your team that dynamic reallocation is a priority and that decisions are final unless there is a
material external change.
·
Create a common language
around resource reallocation that
integrates it into the culture of “how we do things” and stresses its
importance in realizing growth aspirations.
·
Establish clear
accountability between corporate-center and business-unit levels, and determine which resource decisions need whose
approval, what gets monitored and reported, and what escalation mechanism will
be used in case of delays.
·
Regularly review the
assumptions behind allocation decisions to make sure they still hold, both around new investment requests and previously
allotted resources yet to be deployed. If managers are protesting decisions on
resource allocation, is there a reason to update the assumptions?
·
Consider organizational
changes to improve resource flexibility,such
as creating shared resource pools or enabling talent to be more easily
redeployed.
·
Embed dynamic resource
reallocation into the planning process and management incentives. You want to make it necessary and beneficial for
management to continuously seek ways to apply resources for the benefit of the
overall company rather than their own fiefdoms. For example, ask every business
cell to start next year’s budget with 10 percent less in operating expenses;
the combined amount becomes a central investment pool for which the cells compete.
By Yuval Atsmon
http://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/where-how-much-and-how-answering-the-hardest-questions-of-resource-allocation?cid=other-eml-alt-mip-mck-oth-1610
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