In conversation: The CFO’s critical role in innovation

| Interview

As the resource gatekeeper, the CFO is often perceived as Mr. or Ms. No—the key skeptic innovation teams must win over. However, the finance chief can also be innovation’s most important enabler. In the third part of our series of conversations on the CFO’s changing mandate, three experts explore how corporate innovators can make the finance leader an ally rather than adversary. Matt Banholzer, who leads McKinsey’s global innovation delivery work, and two senior advisers to McKinsey—Talha Ashraf, former executive vice president and CFO of US Anesthesia Partners, and Bill J. Pearson, former CFO of Nestlé Waters—spoke with communications director Sean Brown.

Sean Brown: What are the biggest misconceptions around corporate innovation and the CFO’s role within it?

Matt Banholzer: Everyone agrees innovation is good, but there are differences of opinion about what it can accomplish. People tend to think of developing new products, but innovation can also be about new services and experiences, new ways of serving customers, and new business models, all of which create opportunities to drive growth. Business model innovation can include evolving your value proposition or using your assets—both tangible assets such as production facilities and intangible ones like your brand—in new ways. It also links to productivity improvements and process enhancements because new business models can enable you to use your assets and talent differently.

Ultimately, innovation has to deliver what we call “net new growth”—create something that did not exist before—and not just as a one-off. Most organizations can create a single innovation if the CEO and CFO prioritize it and people move mountains to make it happen. But that is not sustainable, and it is not repeatable. The hallmark of innovative companies that people admire is innovating year after year in different parts of their product or service portfolios.

Finally, innovation is not an ideas problem but a resource allocation problem. We have never come across an organization that lacks ideas. The challenge is unleashing innovators by giving them the resources they need—not only monetary but people, time, leadership attention, and physical assets. In some ways, the CFO is the corporate equivalent of the venture capital investor looking at a start-up. It’s just that the start-up is a group of motivated people within your own company.

Most organizations can create a single innovation if the CEO and CFO prioritize it and people move mountains to make it happen. But that is not sustainable, and it is not repeatable.

Matt Banholzer

Sean Brown: Talha and Bill, how did your finance teams think about innovation?

Talha Ashraf: As a CFO, you want to see innovation woven into the fabric of what the company does. I always encouraged teams to not treat innovation as a once-a-month or once-a-year type of exercise but to budget and forecast resources on a continuous basis, so that innovation is an integrated mechanism to drive growth. People also need clarity around the CFO’s expectations on progress.

Bill Pearson: I absolutely agree that innovation is a resource problem, but it is also a process problem, and no one is better positioned than the CFO to help identify, select, and refine the value proposition of the ideas that come up. With a stage-gate process that is definable, sustainable, and flexible, the CFO can sign off during each stage. And these signoffs include math: How do you size the category? What price premiums do you expect?

Sean Brown: The CFO’s priority is that innovation investments produce economic value for the company. A few years ago, we laid out the eight essentials of sustainable innovation (Exhibit 1). How well do companies put them into practice?

Companies that are successful innovators master eight essential elements.

Matt Banholzer: Innovation is not just a culture—it needs to be enabled by a set of practices. When we studied how many of the essentials of innovation companies have mastered, we found the curve is almost exponential. If you only master a few, it doesn’t have a material impact on economic profit. Unfortunately, the majority of companies are in that bucket. They may be setting a good aspiration and allocating resources to innovation, but they are not evolving their business models to capitalize on the new offerings.

Companies that master the essentials of innovation tend to deliver breakthrough economic value.

When you get to five or six of these practices being commonly used across the organization, however, the economic profit is 60 percent higher than if you had done none. And it’s a flywheel: if you master seven or eight, economic profit is 2.4 times the momentum case (Exhibit 2).

Sean Brown: Are any of these eight practices more important than the others?

Matt Banholzer: Aspire and Choose are the most important because unless you set a high innovation goal and allocate resources to chosen projects, people will not pay attention.

Bill Pearson: All eight are important but Mobilize is particularly relevant to CFOs. Over the past decade, successful CFOs have mastered the art of efficiency and productivity, so it’s time to look at the top line. To me, innovation is the Holy Grail. There are many other options for resources—you can put money into capital expenditures or acquisitions—but none are as efficient as innovation. The reason that’s true is leverage. Innovation drives price, and price at the top line (all other things being equal) is probably the greatest multiplier of economic profit. This is the area where the CFO has to put a lot of process in place to grease the organization’s wheels.

Talha Ashraf: Innovation is the long game. If you are looking to the next quarter or the next three cycles, that may not deliver the value you want. But if you have processes in place and the support of the CFO dedicating resources, that can drive sustainable, consistent, and capital-efficient growth and create an energizing narrative within the company.

As a CFO, you want to see innovation woven into the fabric of what the company does. I always encouraged teams to not treat innovation as a once-a-year type of exercise but to budget resources on a continuous basis so that innovation is an integrated mechanism to drive growth.

Talha Ashraf

Sean Brown: How should CFOs ensure that innovation projects get the resources they need?

Bill Pearson: Creating a process is the way to make that happen. All functions—supply chain, manufacturing, distribution—need to participate in innovation, not only by giving up resources but by contributing to the most economically viable solutions. I encouraged this with common metrics, showing there is a payoff for this effort in terms of compensation and other measures of success. Common metrics help the CFO reallocate resources and ensure that you get the most efficient solutions across the entire company.

Talha Ashraf: That resource reallocation includes talent. You want your best and brightest to raise their hands to innovate. One way I tried to motivate those high-potential individuals is by working with other leaders to provide a fast track for them to the next promotion into operating or strategic roles.

Sean Brown: Matt, you conducted a survey that reinforced the perception of the CFO as a barrier for innovation teams. What kind of comments did you hear from respondents?

Matt Banholzer: “We have a bias against taking risk in the company.” “I only have one shot to go to my investment board.” Some talked about timing: not being able to get the money, resources, or people when they needed them and having to wait for the next budgeting cycle. People also mentioned the focus on near-term targets and unrealistic expectations of innovation projects delivering payoffs within 12 or 24 months. But these are perceptions; the reality can change based on how the CFO thinks and leads.

All functions need to participate in innovation, not only by giving up resources but by contributing to the most economically viable solutions. I encouraged this with common metrics.

Bill J. Pearson

Sean Brown: How can the CFO help create an environment where people feel safe to request resources for innovation?

Talha Ashraf: Part of it is the culture. You have to recognize and reward innovation—and make it fun. One way we did that was to apply the Shark Tank concept, a little tongue-in-cheek. We asked people to come to the leadership team with product, service, or process ideas and make the case for funding. We also gave bonuses and recognition to teams that made submissions. That created excitement, which encouraged people who may have hesitated to pitch ideas to go through the application process in hopes of getting selected to present to the C-suite.

Matt Banholzer: Psychological safety is so important. You need to divorce the celebration of innovation outcomes, because you will likely see a high failure rate, from celebrating people who take the risk and demonstrate leadership. Innovators can do everything right and then the market evolves. But if they lead with a bold vision, move forward under uncertainty, that is worth celebrating, both during project reviews and in communications to the organization. “These people took a big swing. They didn’t hit a home run, but we encourage the effort.”

Sean Brown: What role can the CFO play in fostering that willingness to take risks?

Matt Banholzer: We have a concept called “the green box,” which simply represents the gap between your aspiration and what your current revenue and earnings trajectory can deliver. Almost every organization has a plan for three or five years out and a growth model to get there. Between strong performance, portfolio momentum, and M&A, many companies can meet their growth plans. If I am a business unit president and I can meet my goals by doing things I know, I will pull those levers every time. However, if your company’s growth goal cannot be met through those levers alone, you have to look elsewhere—and that’s innovation, the net new growth.

This is where the CFO comes in. When you set the growth goals, you need to be thoughtful about setting stretch targets the organization can reach only through innovation. Those targets cascade because people will be held accountable not just for their quarterly EBITDA target but for revenue or other targets a few years out. When every business unit has a green box, you start to get alignment. It gives leaders legitimacy to allocate resources to innovation and to carve our corporate growth funds or co-fund projects with others. It also creates safety, because people say, “Clearly they are serious about innovation, because it’s part of the growth plan, so I will take that bold bet.”

Talha Ashraf: I agree. I struggled sometimes with the CEO and board members who thought innovation was a nice thing to do but wanted to focus on M&A and getting through the plans. The way I framed it was, “This is the way to exceed plans. This is the way to set the external narrative and, internally, create energy.” With CEOs that were very operational, you need to unpack the opportunity and apply discipline.

Having navigated private equity–backed companies, I would add that in those settings, your time horizon is five to seven years. When you start talking the long game around innovation, you lose some of your key stakeholders. If you can lay it out relative to multiples by which you can drive the valuation increase, that may resonate more.

Bill Pearson: The green box, from the CFO standpoint, starts out as a red box—it’s the gap between what we need and what we have. You can align your team on that burning platform, then do your typical spot analysis not only at the business level but the company level. You can compare how your investments in M&A, capital expansion, and innovation pay off, put some common success measures in place, and schedule this out over many years. “We have a stage-gate process. We will run people through the process. We will meet on a regular basis and every time we meet, we will look at projects in stages one, two, three, four, or five.” That green box suddenly becomes the reality.

Sean Brown: How should the CFO balance the short-term demands and the long-term horizons that innovation requires?

Bill Pearson: You have to treat innovation as a pipeline. It’s not about the once-in-a-while great idea. It’s a regular, definable, repeatable process, and in that process some initiatives pay off earlier than others. Some pay off bigger than others, but later. That’s where the CFO comes in—to allocate resources according to the payoffs and the needs of the organization.

Matt Banholzer: A fluid pipeline is important. If you balance your innovation portfolio between incremental projects and big swings that can create future growth platforms, you need to overfill that pipeline. My rule of thumb is that between 40 and 60 percent of the big-swing ideas fail, so you need to roughly double the ideas at the front of the pipeline. That doesn’t mean 40 to 60 percent of your innovation resources are lost, because you make small investments at the beginning and stop if the project isn’t working.

Keep in mind that the best companies find lessons in their failures that drive success in future projects. Amazon’s Fire phone failed, but the voice-recognition software in it helped make Alexa a success. It’s like the Isaac Newton quote: “If I have seen further, it is by standing upon the shoulders of giants.”

Sean Brown: How do you decide when to cut your losses on an innovation investment that doesn’t seem to be paying off?

Bill Pearson: Say you have five stage gates, and your first gate is volume. “It’s a great idea, but can we make this?” If the project passes the volume test, what kind of pricing can we get for it? Is it private-labeled? Can you get a 20 percent premium off that? If you can do it, then the next gate is how much it costs to make. It’s the fail-fast mentality: you don’t get to spend a lot of time and resources on this until you pass the initial gates. That’s why the process is so critical.

Matt Banholzer: It helps if you reframe the processes around learning. Every innovation has to meet a set of explicit or implicit assumptions, and these are usually nested. There are obvious ones like expected revenue and market share, but if you were to pick apart the assumptions underneath those, such as price point, that gets to the value you can create. As you think about these assumptions, you get more facts. That’s why you run pilots and create prototypes—to get information. If enough of those assumptions turn out to be untrue, it’s a sign that you need to think about pivoting.

Bill Pearson: I have found that if you teach as you go—what is the CFO looking for at each stage gate?—the innovation teams quickly start to address these issues before they bring projects to you. It becomes self-fulfilling.

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