Companies are under pressure from a wide variety of stakeholders to improve long-term business performance across financial and nonfinancial measures. Less than half of CFOs note that their capital allocation process meets their total shareholder return goals, and a third indicate that their capital allocation process and prior investment decisions may make them a target of activist investors, according to the 2021 EY Capital Allocation Survey of more than 1,000 global CFOs.
CFOs can help deliver long-term value by taking an outside-in perspective of their companies' capital allocation strategies. Key questions to consider: What does the future look like, and does the business portfolio have the right assets and capabilities? Who are the key stakeholders, and what KPIs are important them? Do stakeholder communications build trust by outlining a clear investment road map to the future?
Most CFOs note that the pandemic has forced them to completely rethink their capital allocation strategies or processes. Companies that don't respond appropriately to pandemic-related disruptions, from customer demand to supply chains, and advances in digital technology, can disappoint shareholders and even attract outside attention from activists.
Identify all stakeholders and the KPIs that are important to them
Companies are evaluated differently today, in part because they have a broader set of stakeholders – employees, communities, suppliers, regulators – in addition to investors. Viewing the companies' capital allocation strategies holistically and from each stakeholder's perspective can help identify the key performance metrics that are important to each group. While some stakeholders may focus first on financial metrics, others may focus on qualitative factors, such as those related to environmental, social and governance performance.
The key is to choose KPIs that reflect a company's long-term value creation strategy and mission statement. These KPIs can be refreshed regularly to ensure that they continue to align with the strategy and are correlated to project outcomes. Successfully showing that the company has a consistent, agile and effective process for evaluating investments can help satisfy a variety of stakeholders.
Key ways to rethink capital allocation
Below are four ways to approach capital allocation, keeping in mind how your stakeholders will view the business:
- Understand the future state of your business and the competitive landscape compared to your current capabilities. Especially considering the pandemic-induced business disruption, it is likely essential to understand your current competitive position and weigh various future market scenarios.
- Align an investment road map to the overall corporate strategy to identify new assets and capabilities that maybe needed to reach that future state.
- Review your current portfolio to highlight where capital should be reallocated across the portfolio. Determine which assets are no longer fit for the future state of the business or can be better developed in the hands of a new owner – and consider divesting in order to help fund new investment.
- Consider your strategic alternatives to organic investment, including joint ventures, partnerships, minority investments and outright acquisitions, to fill capability and market gaps, especially where investing internally may be too slow or too disruptive to reach the desired state.
Communicate clearly and often
Once a capital allocation strategy is developed to support the overall corporate strategy, it is likely essential to communicate it to stakeholders. Most CFOs realize the importance of employee support and buy-in to the capital allocation strategy, with 69% of CFOs communicating their capital allocation plans with employees. However, only 55% of CFOs say that they communicate their capital allocation plan with investors and analysts, even as 45% say that shareholder feedback is a factor that is gaining importance in their capital allocation processes.
Despite having a well-thought-out and executed capital allocation strategy, a lack of transparency can erode trust. When companies communicate and then execute on their capital allocation strategy, stakeholders trust how the capital investments are part of a cohesive plan and just not a series of one-off events.
Capital allocation can be a strategic driver of long-term growth and can help companies achieve stakeholder objectives. Unfortunately, many companies still have ad hoc or inconsistent processes that hinder these goals. Taking an outside-in approach to capital allocation that focuses on what the future company will look like, aligns the investment road map to that strategy, incorporates objective portfolio reviews and communicates the plan to stakeholders can make capital allocation a long-term growth enabler instead of a short-term fix.
Please find out more about EY's capital allocation services and how our teams can help you accomplish your goals.
Loren Garruto is EY's global and America's corporate finance leader.
The views reflected in this article are those of the author and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.