Adapt Corporate Finance Practices To Support Digital Transformation
We’ve been researching a central dilemma for software leaders over the last year: If software is so important to digital business and customer engagement, why isn’t software development better understood by the C-suite? To foster an environment of fast and valuable software development, CEOs must be in the driver’s seat; they must master software as an essential corporate resource. In parallel, their CFO partners must guide transformation by implementing financial strategies that remove obstacles to experimentation and innovation. These actions may appear to be anathema to CFOs, who see fiscal conservatism and risk avoidance as their core responsibilities. However, in our research, the CFOs in organizations making positive headway in their digital transformations recognize that change is necessary and are more comfortable with putting new, more flexible financial management into practice.
Firms Base Budgeting Practices On Yesterday’s Business
As software is pressed into service to accelerate revenue growth and improve customer experience, dev teams use practices such as fast, time-boxed delivery and tight feedback cycles to meet that demand. But software leaders often find themselves at odds with other practices in their company, such as financial planning, budgeting, and funding practices that remain static and rooted in the rigid, restrictive practices of yesteryear (see Figure 1):
- Functional silos slow the transition to product-driven planning. Traditional planning approaches inhibit product or technology innovation. Senior executives announce the organization’s budget and strategic goals, then functional management identifies individual projects that help them meet their functional objectives. When cost and resource constraints keep it from executing everything on the wish list, the organization wastes significant time negotiating a more realistic list. This cycle impedes the transition to Agile delivery; traditional organizational design for software teams remains firmly in place. Only 18% of software leaders put forming more multidisciplinary product teams among their top three priorities for 2019.[i]
- Innovation budgets take a back seat to ongoing operations. Enhancing or maintaining business operations via technology still accounts for the bulk of software spending. According to software decision makers in Forrester’s 2018 software survey, only 23% of software budgets goes to new custom-developed solutions, while about 57% goes to licenses for commercial software or maintaining existing solutions.[ii]
Figure 1: Traditional Annual Planning Processes Focus On Budget Over Plans
Agile Financial Planning Requires Lean Thinking
Traditional accounting and budgeting practices consider a project as the basic unit of work and allocate people to projects on a temporary basis. This creates unnecessary overhead and is in direct conflict with Agile software delivery concepts.[iii] The demands of digital transformation are driving many organizations to adopt enterprise practices such as Lean management and budgeting practices that support continuous strategic planning.
Fixed annual operating budgets don’t align with continuous planning and delivery cycles — and don’t readily adapt to changing business priorities. A number of companies we interviewed are transitioning to rolling, 12- to-18-month budgets that allow them to respond to changing business priorities while still controlling costs. To invest in software-based differentiation, organizations are allocating their budgets into three buckets: innovation bets, minimum viable products (MVPs) for product/solution delivery, and ongoing ops and maintenance investments for day-to-day operations.[iv] As organizations transition from legacy applications to newer digital platforms, the balance between MVPs and ongoing operations and maintenance shifts toward new products (see Figure 2).
Figure 2: Agile Budget Allocation Buckets
To succeed at digital transformation, it’s vitally important to understand that while software and technology may now be at the core of how companies win, serve, and retain customers, embracing human, adaptable, and outcome-based principles enables companies to be truly Agile. The process must be iterative, focusing on the following:
- Build the right business case for the CFO. Traditional delivery practices lock in costs and resources and minimize cash flow until delivery of the final product — which results in increased risk to the portfolio. Iterative delivery, by contrast, supports consistent cash flow and mitigates risk. Getting CFOs on board requires business-driven discussions between AppDev leaders and the C-suite to clearly identify outcomes and impacts in business terms. Consulting firms such as Tactec Strategic Solutions work with CFOs to build sufficient transparency to get early agreement on go/no-go decisions. They also help organizations build a culture of safe learning and experimentation, including embedding finance pros within software teams to build trust and transparency.
- Start with an educational exercise. Don’t push for broad change all at once. Yes, it’s time to make the transition. But finding the right solution for your organization has to be a joint decision, and it has to provide the right information for everyone who consumes that information. Introduce the value stream concept at the team level to reduce waste at the delivery level, then use that exercise to identify broader value streams that cut across business capabilities. Funding at the value stream level helps organizations identify the total cost of work that delivering products and services requires.[v]
- Put planning first. Traditional planning practices prioritized budgeting over planning. Organizations routinely mix up objectives, strategies, and actions, causing them to jump directly into projects to solve short-term problems.[vi] Lean thinking places the highest-priority identification of objectives or desired outcomes and then prioritizes the actions that achieving them requires. The budget, once all sunk costs such as assets, leases, or other capital investments are accepted, is dedicated to covering internal and external labor costs. For example, ThoughtWorks helps organizations transition their planning practices using its EDGE methodology to identify strategic outcomes and designate bets or ideas for prioritization and funding (see Figure 3).
- Focus on prioritizing products and solutions and funding value streams. This is fundamental to making the transition because it establishes the mechanics of continual investment in software products. Funding products and solutions forces organizations to move from functional resource pools to dedicated, autonomous teams that manage the backlog and are responsible for delivering new capabilities. As products mature and new opportunities arise, organizations can decrease allocation of staff and shift them to new product teams. Software vendor Apptio provides software and services that enable organizations to build a complete solution, including value streams that cut across capabilities and processes that drive product and service delivery. Using value streams enables organizations to identify and fund the necessary work to deliver the best value or leverage safe, high-revenue value streams to fund innovation.
- Partner with auditors to determine capex and opex principles. Current accounting standards don’t provide specific guidance for capitalizing software developed using Agile practices. Companies, especially publicly traded ones, that capitalize software should work with their audit firms to create a model that allows them to determine what to capitalize and how to depreciate assets. Having these models in place helps organizations provide guidance in making tradeoffs between short-term and long-term strategies. One CFO told us that because there is little official guidance available for capitalizing Agile software initiatives, his company had to develop its own set of principles to create and then vet the model with its outside auditors.
Figure 3: Agile Planning Process: Plan, Budget, Deliver
Maintain Business Agility With Continuous Portfolio Reviews
Establishing rolling budgets and using financial performance provide greater flexibility for prioritizing investments. However, achieving desired outcomes requires continuous reviews and feedback. Organizations adopting continuous planning do the following:
- Establish consistent review periods. All of the organizations we interviewed review their portfolios monthly to assess performance. As those organizations identify new products, they prioritize them based on the freshness of the opportunity or the cost of delay. Tradeoffs depend on an opportunity to make money, deliver a desired customer experience, or achieve an operational efficiency. Monthly reviews with departmental finance, planning, and analysis (FP&A) staff look at spending that supports day-to-day operations. Investment changes that may drive significant road map changes are subject to quarterly reviews.
- Get the right people in the room to make decisions. To provide effective prioritization guidance to product teams, organizations bring key executives and product teams together to look at the company’s cash outlays for the year against its P&L statements. As development teams deliver value throughout the year, the leadership team commits to continually assessing the portfolio to determine what assets they will be delivering. For example, the CFO of a collaborative work management software vendor regularly meets with sales, marketing, and product teams to determine the next quarter’s investment plans.
- Create KPIs that link to desired business outcomes. Frequently assessing KPIs based directly on business outcomes lets organizations quickly identify the value of investments and decide how best to optimize portfolios. For example, a media company that previously used ROI as its only criterion for investments shifted its KPIs to improving customer experiences that would drive up subscriptions. In turn, the development organization then prioritized product capabilities that would deliver better CX. The firm monitored product releases and measured subscriptions on a monthly basis to determine the success of the investment. After two quarters, it saw a 25% increase in subscriptions, and it was able to redirect investment into faster delivery of the product.
Introduce New Practices Pragmatically
Budgeting practices must synchronize with software leaders’ adoption of Agile — as Agile is a critical discipline to accelerate value and spur business growth. Software leaders and portfolio management office leaders must work with CFOs to lead the way. Take baby steps, but move quickly. For recommendations on how to fold Agile into your corporate budgeting and financial planning practices, check out my new report:
Digital Business Requires Agile Financial Planning
Our executive and software research is ongoing. Please leave feedback, as well as comments on where we should take it next. If you’d like to share your story and perspective with us, please email me at firstname.lastname@example.org.
[i] Source: Forrester Analytics Global Business Technographics® Developer Survey, 2018.
[ii] Source: Forrester Analytics Global Business Technographics Software Survey, 2018.
[iii] Source: “Lean Budgets,” Scaled Agile (https://www.scaledagileframework.com/lean-budgets/).
[iv] IBM’s three horizons model is one similar approach that categorizes products/investments into three different buckets, each with distinct focuses, metrics, and success factors. See the Forrester report “Develop Customer-Centric Applications Like The Pros Do.”
[v] Practicing value stream management enables organizations to optimize Agile plus development and operations (DevOps) and clearly identify the value they deliver to their business partners. See the Forrester report “Elevate Agile-Plus-DevOps With Value Stream Management.”
[vi] Source: Graham Kenny, “Your Strategic Plans Probably Aren’t Strategic, or Even Plans,” Harvard Business Review, April 6, 2018 (https://hbr.org/2018/04/your-strategic-plans-probably-arent-strategic-or-even-plans).