Few CFOs think their company is effective at managing investments across markets with significantly different growth rates according to a new Ernst & Young report launched this week. Most also lack confidence in communicating this investment balance across divergent markets to the investor community. In a survey of over 750 CFOs world-wide, two thirds replied that they do not believe their organization is good at balancing resource allocation between developed and rapid-growth markets. A similar number find it difficult to convey an over-arching narrative to investors when balancing investments across these markets.
The study, A tale of two markets - telling the story of investment across developed and rapid-growth markets, explores the role of the CFO in balancing investments across developed and rapid-growth markets and examines the way in which CFOs communicate these decisions to investors. It includes findings from interviews with leading CFOs and investors, as well as two surveys conducted with the Economist Intelligence Unit. The first of these surveyed 759 CFOs from around the world and the second surveyed 244 professional investors.
"The vast majority of CFOs are finding it difficult to justify increased resource allocation to developed markets, at a time when other markets are growing so quickly. There is a compelling rationale behind investing in rapid growth markets, but at the same time, CFOs simply cannot ignore the fact that the majority of revenue is still to be found in the established markets. Thus they find themselves having to walk a fine line between allocating additional resources to the rapid growth markets and effectively maintaining the high revenue developed markets," says Lance Tomlinson, Assurance Leader for Ernst & Young, Africa.
Lack of transparency in rapid-growth markets
In balancing investments across markets, the CFO has to constantly manage contradictory forces: the drive to capture the growth opportunities in rapid-growth markets to counter sluggish performance in many developed markets, as well as the need to protect sources of profitability from these developed markets. While both investors and CFOs agree that the best hopes of long-term growth lie in rapid-growth markets, the survey findings suggest that CFOs are not finding it easy to provide an objective rationale for allocating resources to them. Two-thirds of CFOs agree that inadequate data and poor transparency means it can be difficult to build a robust evaluation model to support these investments.
Jay Nibbe, Ernst & Young EMEIA Markets Leader, comments, "The lack of historical precedent and access to reliable data impedes the ability of the CFO to address investors' questions on when to expect a return on their investment. Despite the obvious attractions of rapid-growth markets, the slower-growing, developed markets still account for the lion's share of revenues and profits and need to be sustained in order to fund the growth strategy. It is understandable that, with these different markets, the CFO is finding it difficult to manage the balance."
CFOs should prepare for investor churn across different growth markets and reassure investors personally
CFOs need to consider the need to engage a new investor profile with a different appetite for risk. The significant majority of CFOs (84%) and investors (63%) believe the higher risks and volatile returns associated with entry into rapid-growth markets will trigger a churn in the investor base. The key to preventing investor churn, according to the CFOs interviewed for this report, will be for the CFO to clearly articulate company strategy and keep the investor informed of where they are on the path towards that strategy.
Both investors and CFOs agree that it is primarily the responsibility of the finance leader to communicate changes in investment allocation across developed or rapid-growth markets and that greater investment in rapid-growth markets requires more frequent communication with investors. Yet despite this, investor communication is bottom of the majority of CFOs' list of priorities when considering investment strategy. Jay Nibbe comments, "When you consider the responsibilities of the CFO, from addressing working capital management, investment allocation decisions, and the entire capital agenda of an organization, it is understandable why communication with investors can move down the priority list. However, increasingly investors are looking for clarity about the risk and return horizon for the investments made in both markets. As such the CFO will need to increase their attention to effective communication to the market."
Tomlinson says that both the form and the content of this communication will need to be carefully considered by CFOs, if they are to communicate effectively with their investors. "When it comes to rapid growth markets, it appears that investors seek regular trading updates. There is a clear disconnect here in terms of CFO and investor expectations. The survey indicates that CFOs consider such updates as only the fifth most useful form of communication, whereas investors consider receiving regular updates and analyses on these markets as the most useful form of communication," adds Tomlinson. As companies develop riskier, and more complex, business models spanning developed and rapid-growth markets, investors want more information about how CFOs see the competitive landscape evolving and comprehensive risk management strategies.
"Most investors are indicating that as far as content goes, they require access to more forward looking, timely information. They want to see changes in the narrative, whereby they are provided with more clarity on key risks to the business model and what is being done to manage these risks. Since rapid growth markets have a greater risk profile, investors want more emphasis placed on the provision of a clear and balanced description of how the business model creates value. They also want more clarity on how the various risks are being managed and more granular information about the prospects for particular markets," says Tomlinson.
Investors want more forward-looking, real-time and concise insight
The swift pace of business in rapid-growth markets means that traditional reporting frameworks may be too static to keep investors informed about key developments. Investors want greater immediacy, citing regular trading updates as the form of communication they find most useful for gathering information about investments in rapid-growth markets. This suggests that traditional channels of communication, such as the annual report, may no longer be enough to satisfy the time-sensitive needs of investors. Less than half of investors surveyed think that the annual report is effective at providing details on risks in developed and rapid-growth markets, and only 42% think it is good at helping them to support investment decisions.
Les Clifford, Partner and Chair of Ernst & Young LLP's CFO Program in the UK and Ireland says, "We hear more and more from the market, and from CFOs, that the traditional annual report and accounts is no longer the primary source document as far as investors are concerned. Investors are much more interested in what's going to happen in the future, than what has already taken place. And, they want access to reliable information on an increasingly real time basis. As they rely more and more on information that is generally unaudited, this poses some very interesting and significant questions about the future assurance model for reporting."
Copies of this study as well as others in the Master CFO Series can be requested from www.ey.com/cfo
Stay connected, up to date and in the loop on what is happening in the world of finance by subscribing to our newsletter and following us on Twitter.
Category: guest articles
