CFOs that fail to embrace digital technologies will leave their shareholders vulnerable to under-performance and inferior market valuation. How should CFOs respond to this challenge?
By Karen dela Torre, Vice President, Oracle Corporation
A new piece of research by Open Matters with analysis by Deloitte points to a paradigm shift in the way that companies create value. The study finds that businesses that reduce their dependency on physical assets (for example, plant, property, and equipment) by redeploying capital to digital initiatives are likely to carry valuations up to 4 times higher than their traditional counterparts. The key message for CFOs is that a failure to embrace digital technologies and reallocate funds into intangible assets (customers, talent, intellectual property, and co-creation networks) will leave their shareholders vulnerable to under-performance and inferior market valuation. But how should CFOs respond to the challenge?
The findings, based on a 40-year analysis of Standard & Poor’s 500 Index companies, not only confirms the long-term trend that 80% of market capitalization is vested in intangible assets (versus just 17% in 1975), but for the first time pinpoints what lies behind the change. And although certain business sectors are more amenable than others to digital transformation, the underlying narrative is that ultimately all businesses will become digital businesses.
That said, some businesses have a natural advantage in the digital stakes. For example, companies that develop and sell intellectual property, “Technology Creators,” or businesses that sell products or provide digital content through networks, “Network Orchestrators,” are by their very nature already well positioned in the digital era. They attract a valuation based on a multiple of revenue between two and four times more than so called “Asset Builders” (companies that manufacture, market, distribute and sell physical goods) and “Service Providers” (for example, financial institutions and consultancies). The ability of “Technology Creators” and “Network Orchestrators” to rapidly scale their operations is probably the most influential factor in their higher valuations.
The Deloitte-OpenMatters research also underscores the increasingly influential role that CFOs across all industries have in transitioning their companies to digitally-enabled business models. The CFO’s understanding of the balance sheet and what drives value, together with his or her growing influence in strategy setting and technology decisions, makes the CFO an ideal business partner and agent of change. The CFO’s ability to see the ‘big picture’ will also prove vital, because digital enablement is not only about having an innovative and differentiated business model, but also about having the most progressive and agile business processes, such as, using predictive analytics to identify trends, deploying cloud technologies to drive higher participation planning or leveraging social tools to dismantle functional silos.
Indeed, CFOs are already indicating a willingness to introduce best practices into their core business processes by investing in the adoption of cloud, mobile, analytics and social capabilities. In fact, according to Gartner’s 2014 CFO Technology Imperatives survey, 76% of organizations currently leverage at least one of these technologies. More specifically, the projected use of the cloud has doubled between 2013 and 2014 for business analytics (49% 2014; 21% 2013), integrated financial management applications (49% 2014; 21% 2013) and budgeting and planning applications (38% 2014; 19% 2013). Furthermore, 81% of organizations forecast moving to the cloud for over 50% of their transactions. But there remains a gap between aspirations and action with estimates for the transition to cloud technologies being pushed out further in the 2014 study than earlier studies.1
So moving to a more digitally-infused business and operating model will need to be accompanied by a profound change in mind set. And it won’t be easy. Despite ‘intangibles’ accounting for up to 80% of a company’s market valuation, its composition and definition remains elusive and unreported on the balance sheet—accounting standards have yet to catch up with the digital era. So CFOs will play a significant role in guiding their management team to better understand the organization’s digital potential and to making the case for more digitally—intensive investment at the expense of more traditional investments in older technology, plant, and equipment.
Change on this scale will require strong and innovative leadership from the whole board—not just the CFO—to create the conditions which are conducive to moving forward. Management will need to dig deep into the organization and the value creation process in order to build an inventory of intangible assets and to understand fully the potential for new business models, for example, to exploit under-utilized intellectual property, reassess the value of customer information, or anticipate how the ‘internet of things’ could create new service opportunities. Any new vision that emerges will need to be backed by executive level sponsorship and an enthusiastic board. It may also require organizations to recruit and train new digital talent (some at board level) to champion and support digital initiatives.
In addition, the prevalence of subscription and membership models in the digital economy, as opposed to traditional transaction-based models, could present significant challenge for the flow of earnings in the short to medium term. Businesses will need to be patient during the early stages of development to allow sufficient time for any new model to mature and bear fruit.
CFOs will also need to be prepared to build new metrics, risk and performance measures in order to monitor progress. Digital initiatives do not always lend themselves to traditional measures of ROI; for example, social metrics and real-time sentiment analysis may need to be combined with proven measures such as cash generation and earnings to get a complete picture of the health of new digital initiatives.
However, it is clear that with value creation increasingly correlated with digital deployment CFOs can no longer afford to sit on the sidelines. Oracle, in conjunction with Financial Executives International, recently sponsored new research, Modern Finance in the Digital Age, which explores the role that CFOs can play in driving digital transformation, and the new finance best practices they can use to create more responsive, nimble finance organizations better prepared to support digitally-driven value creation strategies.