Can the capital allocation process be a competitive advantage?

Some companies in the technology, media and telecommunications sector are doing it differently — and seeing results.

A new study from Parthenon-EY shows that, when it comes to best practices in capital budgeting, top performers from the technology, media and telecommunications segments (TMT) might be onto something. That is, these leaders share a handful of common attributes and processes that appear to enhance their overall effectiveness, likely contributing to their well-above-average growth.

Parthenon-EY surveyed 150 executives from a wide variety of sectors, all of whom are familiar with their companies’ capital allocation processes. While there were some small differences in the way capital planning was performed across various industry sectors, company sizes and maturity levels, the most striking contrast was between those companies that were both faster growing and outpacing their peer groups (“well positioned”) and those that were growing more slowly and not keeping pace with their peers (“poorly positioned”). Among TMT respondents, the contrast between the well-positioned and the poorly positioned was even more striking.

The survey pinpoints four key areas where the capital budgeting practices of the well-positioned TMT companies vary from the pack.

1. Greater decentralization and business unit autonomy. Well-positioned TMT companies, the survey demonstrates, tend to have less-centralized capital allocation processes and confer a greater span of capital control to their business units (BUs). For example, BU heads at these companies are more likely to have autonomy, more likely to seek ad hoc meetings with key decision makers, and more able to respond to market fluctuations. Moreover, these meetings tend to be one-on-one, enabling deeper communication and greater clarity.

By comparison, the “fairly positioned” and “poorly positioned” companies tend to have more structured and bureaucratic processes often hamstrung by additional layers of management between BU heads and key decision makers. Those corporate decision makers tend to convene annual meetings and quarterly check-ins, but are less engaged between these meetings. As a result, discussions around core capital allocation decisions are more likely to be filtered or muted, with capital allocation plans tending to be more static or fixed for each cycle.

2. Greater frequency and flexibility. Well-positioned TMT companies are much more likely to describe their capital allocation decision making as fluid or ongoing. Such companies begin with an annual, formal discussion, but they revisit allocations quarterly and are more apt to encourage ad hoc meetings.

The poorly positioned companies are less able to respond quickly and have longer intervals without recalibration. These firms tend to over-allocate capital from the start, adding greater uncertainty into their models and projections, with interim adjustments unlikely except for dire circumstances. As one executive explains, “Things can come up in the middle of the year, but aside from [emergencies], it’s basically a once-a-year process with little new action.”

3. Greater use of data. Capital allocation at well-positioned TMT companies is, according to the survey, a decidedly data-driven process. Such companies are significantly more likely to review key business metrics and performance using advanced analytics and visualization. They also tend to be more comfortable sifting through large data sets. As a result, these companies are better able to identify specific metrics that are more effective or otherwise simplify and streamline decision making.

As one executive explained, “I’m seeing more data coming into the decision.” But an important caveat, the executive cautions, is the need for consistency of data across the evaluation timeline. To be effective, “there has to be a track record with the data; you have to have some history.”

Those in the poorly positioned growth segment are relying primarily on financial models whose principal levers include comparables and historical performance. Advanced data analytics and statistics are used sparingly at such firms in favor of traditional capital budgeting metrics. As one executive explains, “We look at the expected internal rate of return of a project and account for the standard deviations around it within our forecast models.”

4. Emphasis on focused, fair and accountable allocations. According to the survey, well-positioned TMT companies are more likely to make capital allocation decisions that promote focused investments (as opposed to dilution across disparate projects). They feel that their allocation is more agnostic to company politics and more likely to be focused on the BUs most likely to create value. They are also more likely than their poorly positioned peers to hold BUs accountable for previous forecasts during the capital budgeting process.

In these three areas — focus, fairness and accountability — the well-positioned TMT firms stood out from the well-positioned non-TMT firms and their poorly positioned counterparts, with accountability serving as a key differentiator. As one executive put it, “It’s not just, ‘Hey, I’ve set my budget for the year; now leave me alone.’ It’s ‘No, we’re holding you accountable monthly now.

Read the full report here.

EY Legal Services Contacts:

nley_nllambr2_lthumb

Rutger Lambriex – Operating Model Effectiveness (OME)

 

desey_dejschu2_LThumb

 

Jan Schulz  – Legal Entity Rationalization (LER)