CFOs risk profitability by underestimating rapid growth market costs

CFOs are underestimating the costs and time involved in entering rapid growth markets according to a new Ernst & Young study. Over a third (36 per cent) of respondents said overall costs were higher than expected and 43 per cent said the investment took more time than anticipated. The study, What lies beneath? – the hidden costs of entering rapid-growth markets, is based on a survey of 921 CFOs from 59 countries around the world as well as in-depth interviews with CFOs from developed and rapid-growth markets.

Jay Nibbe, Ernst & Young EMEIA Markets Leader, says “CEOs and CFOs are increasingly asked by boards and investors to outline how they are capturing the potential in rapid-growth markets. CFOs are uniquely positioned to give their perspective on the growth opportunity, as well as investments required for rapid-growth markets. However, the CFOs we talk to also tell us how important it is to consider the risks to sustaining investment post entry, and also the unanticipated costs which can dramatically alter the initial promise of the opportunity. How CFOs monitor and react to those risks will determine whether they are minor obstacles, or a major miscalculation on cost, which can have a negative impact on investing in these markets.”

Operational costs were considered of particular concern by the CFOs surveyed, due in part to the typically low margins in the high volume markets, with 36 per cent of respondents saying these costs were higher than expected. The area of operational overspend that was judged most likely to occur related to R&D investment, with 35 per cent of respondents reporting a miscalculation. When asked about the future of R&D investment as it related to new product development, almost three-quarters of respondents say that they plan to increase R&D spending in the next 12 months, as they open new R&D centers with a remit to innovate for these markets. This is particularly the case with respondents from high performing organizations[1]. CFOs are also overspending on integration and harmonization of reporting frameworks to meet global reporting standards.

Other costs causing concern for CFOs

A core competency of the CFO - financing costs - was the overall aspect of investment in rapid-growth markets where costs are most likely to overrun, according to 38 per cent of survey respondents. One of the reasons for this could be due to surging capital flows into rapid-growth markets that are stoking inflation and impacting exchange rate exposure. In addition, costs relating to securing the right talent in these markets were also found to be a key area of spending exceeding expectations, as demand for talent outstrips supply. Finally, in the area of political cost, management of risks and exposure to bribery and corruption is the leading reason for unanticipated expense. Those CFOs interviewed very clearly advise that a “zero tolerance approach” is key.

CFOs need to go the distance

According to the survey respondents, CFOs play a slightly more active role at the pre-entry stage of investment that at the post-entry stage. While 29 per cent of respondents say they play a leading role at the pre-entry stage, only 20 per cent say they do so during post-execution. However, the leading CFOs who were interviewed stress the need for involvement at all stages of the process to safeguard the promise of investment and sustain growth in markets where change is rapid. While it may not be practical for the CFO to stay close to every investment in a global portfolio, the ability to delegate and secure the right balance of local and group finance expertise is critical.

Jay Nibbe concludes, “At a time when many developed markets are being buffeted by economic turbulence, rapid-growth markets, are encouraging a massive reallocation of capital and resources. The CFO has to strike the right balance between accelerating the investment in these markets, while monitoring and controlling the pace and method of investment. CFOs should develop the investment plans with the right on the ground talent to support these plans, with ongoing involvement and oversight of the entire investment process for as long as necessary.”