The importance of smart resource allocation for CFOs

It is a given: among the imperatives of today's business processes for the finance function and for chief financial officers is smart resource reallocation.

A recent research by PwC confirms that the strategic redeployment of capital can boost profit margin, and this in turn poses the challenge for CFOs: overcoming biases.

According to PwC’s 27th Annual Global CEO Survey, a question CFOs should urgently be putting to their chief executives is the query on the amount of human and financial capital the company reallocate from year to year.

The data analysis, which was made by Shir Dekel, Analytics and Survey Design Expert, Global Thought Leadership at PwC, shows that higher rates of resource reallocation are associated with higher profit margins, suggesting that most companies could increase profitability by reallocating more actively.

The difference in profit margin between significant resource reallocation (31–40%) and low reallocation (0–10%) is almost four percentage points, implying that this relationship breaks down only at extreme levels of reallocation. 

The finding aligns with prior PwC research showing that dynamic resource reallocation improves overall company performance because better-performing units or initiatives get more funding, and thus grow faster, while poorly performing units or initiatives are cut or slowed.

Cognitive biases

The reason why research continue to show that many companies still subsidise lower-performing units using funds from higher-performing ones is because cognitive biases are often the culprit.

Among the most common: the sunk-cost fallacy (a reluctance to abandon a project because a lot of money has been sunk into it), anchoring (overreliance on arbitrary benchmarks), and naive diversification (the tendency to allocate equally between available options instead of weighting investments strategically). 

Overcoming these and other biases should be a top priority for CFOs, especially those facing reinvention pressures.

Recommendations

For CFOs, smart resource reallocation requires disciplined processes and nuanced decision-making. PwC recommends three proven practices: 

• Take a ‘portfolio view’ across the company, and rank projects and initiatives by profitability. Projects towards the bottom end of the ranking should be considered for culling, and their resources reallocated to those meeting a certain profitability threshold.
• Hold project reviews with small groups of stakeholders who have a high degree of independence. Doing so is likely to reduce the influence of power dynamics on resource allocation decisions. 
• Remember that reinvention is about more than M&A. The complexity of deals and the significant variance in financial returns should serve as a reminder that internal capital redeployment may be an under-utilised alternative to transaction-driven reinvention.