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May 10, 2019

The Impact of Organizational Complexity on Finance Performance

By Nilly Essaides  – Senior Research Director Finance/EPM/FinOps at The Hackett Group

Can digital transformation be the end-all solution for achieving world-class finance status?

While it can have a huge impact on performance, it should also act as the trigger for broader changes in finance’s overall service delivery model, for example analytics and information management, human capital and service design, as well as the subject of this blog – organizational complexity.

Breaking it down

Complexity is an amalgam of different factors, all of them related and often specific to an industry or company. To assess levels of complexity, The Hackett Group constructed a “complexity index.” The index uses eight proxies. Some are innate, for example the company’s number of tax domains and active customers. Others are “addressable,” for example number of financial systems and legal entities. We filtered our finance benchmark data through these complexity proxies and measured the efficiency and effectiveness differences between them.

At the highest level, finance cost as a percentage of overall revenue at low-complexity organizations is almost 60% lower than in finance functions that operate in highly complex setting; they employ 66% fewer staff and spend 30% less on technology per $1 billion of revenue.

It’s not all about efficiency. Finance in low complexity organizations are also more effective. For example, they make 25% fewer billing mistakes and have much greater acumen to partner with the business.

Getting Practical

Yet this aggregate measure of the effects of complexity doesn’t tell us how to reduce it, because some of the proxies our outside finance’s realm of influence or should not be changed. Pulling back globally or turning away customers is certainly not in the company’s best interest.

To make our index more useful, we zeroed in on the three complexity factors that finance can address and most highly correlated with its performance. Those turn out to be: number of legal entities, bank accounts and finance systems. In all three cases, we discovered that complexity has an outsized effect on finance performance.

The fewer legal entities, the easier the consolidation process and the lower the number of intercompany accounting staff. Technology consolidation means lower cost of maintaining legacy systems and the ability to self-fund investments in smart automation. In addition, a smaller number of bank accounts significantly impacts treasury costs.

Three Action Items

Finance can reap substantial benefits from reducing the complexity of its operating environment. To get started, it can focus on these three factors:

  1. Revise the legal entity structure: Start by identifying opportunities for consolidation, for example multiple legal entities in the same country. Scan for entities inherited through mergers or acquisitions. This inventorying process should not be a one-off effort. A solid governance framework for establishing legal entities will prevent unnecessary proliferation. Authority to approve legal entities must rest at the most senior level, with the treasurer and tax director.
  2. Rationalize finance applications: System proliferation is endemic in many finance organizations. Not only does finance depend on different enterprise applications, it also suffers from the effects of uncoordinated digital initiatives that are not well aligned with its transformation agenda. Start by developing a short- and long-term digital transformation strategy for determining and prioritizing the launch of new technology initiatives. And work with IT to identify applications that can be eliminated, modernized or replaced. One good place to look for redundancy is in bolt-on solutions, i.e., niche software that is hard-coded into current systems to plug functionality gaps. The problem with such solutions is that that they break as soon as something shifts in the underlying system. Dedicated SaaS solutions, which are soft-coded, can often make them obsolete, removing a whole layer of brittle IT architecture.
  3.  Reduce the number of bank accounts: Rationalize the number of cash management banks and migrate accounts with other institutions. Even at large companies, two global banks can suffice; they build in enough capacity to quickly switch out of a bank at the first sign of financial stress. Just like with legal entities, it is important to remain vigilant to prevent future account proliferation by establishing a cash management policy. For regulatory and expediency reasons, local managers will have to be signatories on some accounts. But only the CFO and treasurer should have the authority to open a new account in the company’s name.

Conclusion

Complexity is not only costly, it’s also a major hindrance to developing functional agility, or the capability to respond quickly to changing market and internal conditions. That’s a critical feature in a digital world, characterized by intensified competition and unrelenting business change. In The Hackett Group’s 2019 Agility Study,we found that organizational and process complexity are the second and third biggest inhibitors of becoming an agile finance function.