316. Your budget is killing your strategy: 4 imperatives for CFOs

0:01Matthew Maloney: CFOs are looking back and saying, we've got this army of people that are doing things in a very archaic, backward-looking way. Am I really taking full advantage of the resources that I have and the data availability, and particularly with AI in the last few years, to drive strategically my business? Am I really driving this year over year in the way that my investors are looking for me to have the company perform? From McKinsey & Company, I'm Sean Brown, and welcome to Inside the Strategy Room. That was Matthew Maloney sharing how leading CFOs are thinking differently about budgeting. In today's dynamic business environment, traditional annual budgeting processes are proving more than inefficient.

0:41They're actually undermining company performance. Matt and his colleagues join us today to discuss how outperforming organizations are evolving the budgeting process from a way to track and control spending to a mechanism for turning strategy into action. They offer four imperatives for CFOs, more closely linking budgets to strategic priorities, being more nimble in shifting capital, employing multi-scenario planning, and using AI to turn operational data into forward-looking insights. And now I'd like to welcome two of my colleagues from McKinsey. Matt Maloney is a partner in our New York office and co-leader of our CFO practice.

1:22He's also a leader in our private capital practice. And Michelle Tam is based in our Chicago office and is a senior expert in our corporate business functions practice. Matt, Michelle, great to have you here with us today.

1:34Matthew Maloney: Great to be here, Sean. Thanks, Sean. Excited for the conversation. And I'd also like to welcome Karen McLaughlin, who's a senior advisor to McKinsey and the former chief financial officer of Cognizant Technology Solutions. She served in that role from 2012 to 2020. me. Karen, it's great to have you with us today. Thank you, Sean. I'm happy to be here. Okay. Really excited for this conversation. And Matt, perhaps the title of your recent article is a great starting point. Your budget is killing your strategy. In the article, you talk about the ways in which traditional budgeting is not just inefficient, but how it can actively undermine a business's performance.

2:13So can you talk us through why this is something that all executives should be trying to address and why now?

2:20Matthew Maloney: Yeah, great, Sean. Look, the process that most folks look at and drive is fairly inefficient and oftentimes ineffective and can be strategically corrosive. Three main reasons for this. One, it's oftentimes very backward looking. It starts with last year's spend and there's an aversion to changing anything, downside risk and things and grounding that versus the through cycle, big, bold moves that they've signed up months ago on a multi-year strategic plan. Second, there's this idea that it reinforces incrementalism, right? So it's moving capital around in very, very small ways, people and investments versus linking those investments to your long-term strategy.

3:02Matthew Maloney: And the last thing is, is things get locked into silos. It's kind of politics over performance where everyone's trying to solve for their own business units, their own product or their own service versus the overall enterprise value of the company and how to drive that. Got it. But most companies have followed that traditional backward-looking approach to budgeting for a very long time. So if this process is so broken, why has it endured for so long? Sure. So if you think back, finance 100 years ago was people tabulating on pencil and paper in a calculator, if at best, or an adding machine, and then physically putting those pages together.

3:40Matthew Maloney: That all changed in the 50s with mainframe computers and then changed radically again in the early 80s with what was Lotus Notes and eventually Excel where people could interact with it. What you've got now with the combination of both the disruption we saw with COVID as well as all the supply chain disruption more recently, things are moving much faster. Things are much more global and the access and availability of the data is all there. And so then CFOs are looking back and saying, we've got this army of people that are doing things in a very archaic, backward looking way. Am I really taking full advantage of the resources that I have and the data availability and particularly with AI in the last few years to drive strategically my business?

4:20Matthew Maloney: And so when you're getting into the budget where the budget becomes the grounding for all discussions because it's tied ultimately to incentives and comp versus am I really driving this year over year in the way that my investors are looking for me to have the company perform. And Karen, it'd be great to get your perspective here. You were CFO for a number of years at Cognizant. How did you see the budgeting process evolve during your tenure? Yeah, so I think Matt's right. particularly I was thinking back on my journey at Cognizant, but it's really been, I would say, the last sort of 15, 16 years that I think I've seen a big shift in this and how we thought about at Cognizant as our business started to mature and our marketplace changed and what clients expected from us changed.

5:03We really needed to change our business. And that made us think very differently about how we invested in the business, which then ultimately led to changes in how we budgeted, right? Because we had to budget for those investments to drive the new changes in the business that were becoming important for us. And it's evolved. It takes time. There's a lot of cultural change that has to happen to drive these kinds of changes. But first and foremost, having the data and the ability to make the process changes is important. And then the cultural and people changes that need to come with that. So Matt, your article suggests four steps or imperatives that leaders can follow to evolve their approach to budgeting and better link it to strategy and performance outcomes.

5:44Maybe you can walk us through those now at a high level.

5:48Matthew Maloney: Sure. What folks are doing today, and we share four best practices that people are, this is not science fiction of what's going to come in the future, but rather they're doing this today. And if you're not doing it, you're going to kind of be left behind. So one is starting with your strategy, not last year's budget. What is that multi-year growth strategy to drive enterprise value and performance of your company? Each company comes up with some version of that looking five years out. And is it a hope and a dream? Or is this actually where you're going? Second is reallocating continuously and not annually, right?

6:20Matthew Maloney: Does your allocation of both capital and people investments tie to your strategy? Or are you then locked in and kind of forget the strategy and go into the one year plan and you're going to spend what you've put down on the paper and not move? Third is multiple scenarios with a proper risk and opportunities discussion on a monthly basis to drive operational performance and ultimately then the financial outcomes versus a sort of a single forecast that gives a false sense of certainty. And then lastly, as I mentioned, the idea that AI and data, all the blockers and ways in the past that folks have said that they couldn't have access to the information real time and to be able to discuss and debate the decisions that need to be first and foremost on the executive team's mind, that is now not science fiction, but that's a reality.

7:08And in your work with clients on these four imperatives, how do they typically play out? Are they pursued in sequence or are they pursued simultaneously? And are any of them harder or easier to pursue than the others?

7:21Matthew Maloney: No, this is not a series. It's not a one, two, three, four. This is something that you can do all at the same time, a bit of like changing the tire on the bike while riding the bike down the hill. You can't wait around for everything to be perfect in a sense. And so the biggest challenge ultimately, which I think we should discuss quite a bit in the time we have today, is the cultural change. It's not a perfect system or some sort of a tech tool that's being rolled out. It's the way of thinking both from the CFO and CEO, but also throughout the organization as to driving again that long-term strategic value, not being tied in and being boxed in into the annual budget, the monthly business cycle, and just talking about how things are varying versus that, versus driving truly the performance of the company, which I'm sure Karen has more than a few thoughts on from scaling Cognizant to what she had done in her prior role.

8:13Yeah. So Karen, was this actually something that began with you and the CEO collaborating to change the way that things were being done? And how did you then think about an act to scale it through the organization? So for us, it really was about our strategy and also a little bit of fear, to be honest. Fear can be a great driver of change because we saw our world changing and we saw what clients were demanding of us changing and their expectations changing. And so we knew we needed to change to accommodate that. And we had a very large organization, a lot of people. We ended up thinking about the business in a three-stage model, H1, H2, H3, which a lot of people have used in the past.

8:54But that allowed us to really focus then on the H2 and H3 businesses, which are our newer strategy businesses or parts of the strategy, and really thinking about what do we need to do to make those successful? Because if we don't make those successful, ultimately, we won't have a successful business long-term. Thanks, Karen. And now let's dive a little bit more into the four imperatives. Michelle, first, if strategy is the starting point instead of last year's budget, what does that actually mean in practice? How do you make that happen with your clients? Absolutely. This is a really important place to start because we think that the budget should be in service of helping an organization deliver on its strategy.

9:34And what unfortunately we often still see amongst many of our client organizations is that they start with a world where the budget is simply a small tweak versus last year. So for example, we're simply going to stick with last year's expense budget, OPEX budget, across all of the different divisions of the of the organization, plus 2 % or plus 3 % for inflation. Or we're going to expect from a revenue or an EBITDA standpoint, the same expectations from versus last year with 3 % growth built in on top of it. And so what that doesn't really reflect is how to make sure we are investing in the biggest strategic important priorities for the organization.

10:13And so we think organizations can do this better as they think about identifying the most important strategic priorities and making sure that they're building the business cases against them to ensure that those priorities are getting funded each year. And what that might mean is that that's going to require different parts of the organization to have a very different budget from year to year because of a particular strategic priority that they need to be able to fund. That's also going to require prioritizing against all of the different strategic priorities in the organization. And that's going to require ranking many of those projects against each other to make sure we can afford all the things that are most important for us to deliver on our strategy.

10:57And that will help organizations really be able to fund much of the growth. And so we encourage clients to really ask the question, you know, is your budget actually funding your strategy or is it really funding a pattern that you had in the past, your strategic priorities of the past versus where you want to head in the future? Michelle, in theory, linking budgets to strategy and this forward orientation makes a lot of sense. And perhaps in the past, if strategic priorities weren't expected to change much year to year, budgets could stay reasonably static too. But with this new approach, I'd imagine that more directly linking the budget to forward-looking strategic priorities might inject also a lot of uncertainty for folks, especially lower down in the organization, where maybe last year they were working on something that was a priority, but this year it's no longer a priority.

11:50And all of a sudden, they're now having to shift gears, roles, or maybe even divisions. It sounds like success really depends on the organization changing its culture. It does. I think culturally across the organization, it really does require organizations to move more nimbly. And that requires people deep in the organization to appreciate that what they might have been working on this year might look different than what they might work on next year. And that oftentimes is as a result of reacting to the broader macroeconomic environment, what's happening with competition. That's natural, right?

12:24And that we think is one of the best ways to help organizations ensure they're still able to deliver on their strategic priorities, even as the world around them is changing. So that is going to mean for many organizations, some of that cultural shift towards being more nimble. And how do you know if your budget is indeed funding your strategy? Karen, maybe you can help us bring this to life with some of the metrics that you and the CEO used to track and drive this at Cognizant. Yeah. So for us, for all of our key initiatives, we would have metrics and expectations throughout the year, right? And so typically we would have a quarterly review meeting, making sure that we were staying on track with those initiatives.

13:06And I think it's really important that when you set the investments and the budget for your initiatives, you really get behind it and support it and make sure that you're staying on track because it's easy. I was just saying, right, there's so many other things happening in the world today, whether it be COVID, supply chain disruptions, whatever it might be, And it's easy for companies to get distracted and say, we've just got to run the business and we don't, you know, we got to shut everything else down. But the reality is you need to protect the investments and the strategic initiatives, but really make sure you're staying on track and that you've got the right initiatives, right?

13:39Be willing to fail fast, but then take those dollars and reinvest them where it might be more appropriate. And Matt, just to change gears a little bit, you work a lot with private equity clients And in many cases, their portfolio companies need to move very quickly. And I'd imagine it's even more critical for those companies to have their budgets align very closely with their forward-looking strategy. Do you generally see a more nimble approach in use there?

14:07Matthew Maloney: It is, Sean. And it's one of the friction points typically when a private equity firm acquires a company that was either private or publicly traded before, because the first thing you're going to look at is to say, okay, show me your three to five-year strategic plan and financial plan. And that's going to then be very quickly tied up to what it was the investment thesis, which the sell side and as well as the buy side had put together. And those two typically have a fairly large gap between the two of what is the dollars that we need to be able to deliver in the timeframe that's much shorter than typical cycles for publicly traded companies and even privately traded company, privately held companies.

14:49Matthew Maloney: But then all of a sudden you've got to come down and say, okay, there's a, there's a pretty sizable gap in what we need to be able to deliver in a timeframe. And what are the initiatives as, as Karen and Michelle highlighted that are going to close that gap? Because just putting a plug into the back to the budget again, that's not going to deliver anything. And so you're going to need to have a pretty honest and, and, and deep conversation as to where there are sources and levers that you can pull to drive both, you know, the top line growth market expansion and as well as margin. Right. And that's not a very easy conversation to have because folks, again, have done that for years and years and have driven the business well, but not necessarily at the pace and at the scale that the new board is looking.

15:32Got it. Thank you. So this brings us to the second imperative where the idea is to reallocate resources continuously. And I'm curious to ask, I'm not trying to be too provocative, but if you're going to be reallocating continuously, then why even do annual budgets? Michelle, maybe you could talk a little bit about what role the annual budget plays in this new world that we're discussing today. I think the annual budget still continues to ground the organization on what are the expectations that we need to continue to make sure that we are moving towards. And going back to Karen's point about those metrics, I think it also helps the organization understand the resource allocation that they should expect.

16:12Really understanding the getting grounded in the expectations for the organization and making sure that the broad organization, from the leaders all the way down to folks in the organization that are working to deliver it, understand what the expectations are. That's still an important mechanism to be able to keep everyone grounded. Yeah, I would agree with that. I think especially, well, two pieces, right? One at the senior level, grounding, market guidance, all those things, right, I think are important. And then at the more lower levels of the organization, a lot of times it does become a factor in the comp structure.

16:44And so knowing what people are being held against, I think is helpful. I do think at the senior levels, it's important for the executive team to work with their boards on the comp structure, right? Because you may not want the comp to be tied to a fixed budget per se of just dollars. I think you really want it to be tied to things that are funding about the strategy outcomes and so forth, right? Other types of metrics. And as we've looked at this over the years, you know, the companies that do this really well actually generate much higher returns than those who don't. And so I think as the world has become faster, pivoting, constant change, right?

17:22It's only gotten faster and faster over the last 10, 15 years. This notion of being able to move dollars around, invest in your strategy has only become more and more important. And I think when companies don't do this well, and COVID is a great example, right? World came to a halt for many people, lots of crisis around the world. Companies were just doing what they needed to to survive. But a lot of companies ended up pulling back on their strategic investments at that time. Fast forward five years later, you've come out of COVID. The world is a very different place now. and yet now a lot of big companies are finding their behind because they did pull back on those investments and didn't keep it going during the crisis.

18:05And so I think really protecting these dollars, making sure you start with the strategy first when you're doing your planning cycle, carve out enough dollars to make those investments, and then figure out how to run the business with what's left over, not just a plug, has become critically important and will continue to be so as we move forward. Thank you both. And the research tells us that those that do this well, the outperformers, are actually shifting 10 to 20 % of their resources around annually. So Karen, how did you actually identify the right opportunities to fund with that shifted capital?

18:40Because it's not just about allocation, you want to make sure that you're allocating to the right place. You have to be right. And I think you have to be very focused on your strategy, you, right? It can't be a peanut butter. We can't have 15 different initiatives that we're just going to spread across. I think you'd be very clear on what are the top two or three priorities for your organization. What is required to make them successful? So it's everything from the talent, the technology, partnerships, acquisitions, whatever it might be, that you're really clear about what are the things we need to do to make this initiative successful and get behind it.

19:14Really make sure you have buy-in from the leadership team and from your board of directors that this is where the company is going to focus. Now, I will say when I was at Cognizant, we also kept a pool of what I would call almost venture capital money, right? And so we would set aside a fund every year that was for small startup type initiatives. We didn't know if they would become big opportunities or not, but it gave our teams a chance to go out, try new ideas, but fail fast. So we had gating mechanisms and teams would have to come and report to us and we would shut things down very quickly if the projects weren't working, but it did allow for some of that creativity and allow us to work on some things on the side that maybe were separate from sort of what I would call the big corporate strategy.

19:58And Matt, is this also how you see things happen in PE? Do you see Portco's, for example, doing these same reallocations? And is it typically driven by the operating partners working closely with the CEOs? Tell us a little bit about how this comes to life in that context.

20:13Matthew Maloney: Yeah, Sean, it's a great question. So ultimately management teams are what drive the companies. It's just that there's knowing that both the board, operating partners, advisors, et cetera, are all there kind of in the room with them, looking at, pointing, trying to figure out, again, knowing that from a perspective of if you've got a basket of 10 initiatives, a few of them will be really great, huge returns. A few of them are going to be complete dogs and a number are going to be in between, as Karen mentioned. The idea is, is how do you figure out which are the ones that aren't working very, very quickly to kill off?

20:46Matthew Maloney: But what you'll see oftentimes in PE is the big, bold moves to release even more, not even through a central fund, but fund capital projects and others that were never even envisioned because some opportunity or market disruption came through. and I can invest something that was never even thought through, quickly grab the board and say, yes, let's invest$100 million in a brand new product or a brand new service because we see the disruption. There's not the constraints of the quarterly reporting and returns and annual forecasts and things that you're sharing with the sell-side analysts. And so you actually have a bit of a release on that to run faster because ultimately it's not about delivering what is the budget, but rather delivering the endpoint in the three to five-year hold period within private equity.

21:28Matthew Maloney: And I think a lot can be learned from that to try and move off of the shackles of what is the quarterly cycle to really have that through cycle thinking and not to say, well, just because I didn't envision it four or five months ago when we did our strategic plan for the year, why can't I free that up or reprioritize within the year, given it's such a big opportunity? We all want to get behind it. And as what Karen mentioned, that's where it's really critical to partner with the board, because if you're going to make some big, bold move, you need them to also put their hand up and say, yes, I agree with you.

21:59Matthew Maloney: Let's go do this. It may not turn out exactly the way that everyone's hoping for, but you're now all on the same side of the table. Thank you, Matt. And Michelle, a question for you now. As companies and their finance teams start to engage in this more agile and more significant reallocation approach, finance is expected not only to gather the information and tie it to the strategy, but finance also needs to communicate this both to the external markets and internally in the organization. So could you talk a little bit about some of the best practices for communicating the why on this continuous reallocation within an organization?

22:37I've worked with a number of organizations that I think that's been a challenge for them, right? To be able to ensure that the folks within the organization understand what is the strategy, why are we moving in certain directions? Why does it feel like we might have pivoted from year to year or from quarter to quarter in terms of how resources are distributed amongst the organization? So I do think messaging the strategy in a way that is easy for the organization to understand. What are the three or four key points of the strategy and why is this important to the success of our organization? I do think that messaging is particularly important for employees within the organization, as well as external investors and external stakeholders to really be able to understand why are we making the choices that we're making.

23:24All of that is in service to these three or four key strategic priorities that we have said are the direction that our organization is headed within the next few years. And so being able to do that in a really crisp, clear way, in a consistent way, as much as possible, right? The strategy is not what's changing from year to year, from quarter to quarter. Ideally, a strategy is something that sticks around for a few years, right? That messaging, though, is I think what's important for organizations to understand. We're changing how we're allocating our resources because something macroeconomically might have changed.

23:59Our competitors might be doing something differently. We still want to be able to march against these three or four key strategic priorities. And Karen, how did you keep people excited and on board as opposed to feeling like they were constantly getting pulled in different directions? So I think the communication is key, as Michelle said, and really making sure that filters down the organization consistently. I also think it's important that you show the importance of the strategic initiatives. And some of that is by moving people around. because a lot of times people in a large organization think that their sort of worth to the organization is tied to the size of their P &L.

24:36And the reality is most of these new strategic initiatives don't have any significant revenue to start with, right? That's the whole point of them. And so I think by moving people into some of these initiatives, right, really showing the importance of their strategic value to the company and getting people off the mindset of the size of my P &L measures how I am valued to the company And that's what drives my promotions and so forth is a big part of this. But Karen, at the same time, if we're ruthlessly pruning initiatives and someone gets moved onto one of these more risky ventures, how did you help ensure that the top performers you were moving stayed motivated and excited, especially if their compensation, for example, might have been at least in part connected to the success of that more risky venture that they were now driving?

25:26One of the things that we did when we would move people into some of these new risk, quote unquote, riskier initiatives or startup type businesses for us, we would also make sure to protect that person. So if there came a point in time where we decided that the initiative wasn't worth continuing, we would make sure that assuming it wasn't, you know, just because the person didn't perform. But assuming they were continued to be strong performers, we would make sure we protected that person to find them another role in the organization and keep rotating people through. And it was a great way for us to also identify talent in the organization that might have been two or three layers down, pull them up, give them new opportunities, and let them continue to drive their own growth.

26:05Now to explore that communication piece a little bit further, I'd imagine that over time, as the organization starts to see the fruits of these reallocations, there might be more and more buy-in. So Karen, when you were in the CFO role, how did you help communicate that big picture and those benefits? So I think communicate, let people know in the organization what's happening, let them know the good and the good and the bad, right? You have to be transparent. You have to be honest with people, but celebrate those successes, even if they're small. And we had a very entrepreneurial culture. I think many companies do today, right?

26:41And so the notion that we could allow people to continue to build the next wave of our company and what we were going to look like was really energizing for a lot of our teams. And so we like to celebrate those successes publicly across the company. Super. And so we're making these bold bets now. We're reallocating to hopefully better and higher impact initiatives, but you also want to be able to build in some resilience because there's always risk and you don't always know what the outcome is going to be. So maybe Michelle, now you could talk us through the why and how of that third step. Absolutely.

27:15The world is volatile, right? And so to put all of your eggs in the basket of a single point forecast is a false level of precision. I think it's very difficult for any organization to have a perfectly accurate single year budget. And frankly, I don't think I've ever seen that in 25 years of doing this. I think what's important is for organizations to anticipate different scenarios and recognize that because the world is uncertain, identifying how in a driver-based plan, so understanding what are the primary drivers that are likely to move the needle in your budget or your forecast, and thinking about the different scenarios for how those drivers might interact and how they might move.

27:55I want to make a clear distinction. This is not a sensitivity analysis. I see many of my organizations that I work with think about, oh, we do this, and all they're really doing is a sensitivity analysis. us. The important thing here is this is about scenario planning. So what are the opportunities and what's that bias to action that if a particular scenario were to materialize, what are the actions that we need to take to be able to either protect against that, mitigate it, react to it, or frankly capture the opportunity if that particular scenario materializes? And sometimes that may require there to be some contingencies built into the budget.

28:34And those contingency funds or pools do need to be governed very closely. So this doesn't mean that everybody should have PAB throughout their budget, but that centrally there's a process to be able to release those funds or to be able to release that contingency as needed should a scenario that you have anticipated come to fruition. And we've already talked about the idea of how you might be able to fund from a VC style standpoint, the idea of really exciting opportunities that might arise during the year that allow you to have the opportunity to react to different scenarios. I think the important thing there is making sure you've got the right funding gates and milestones to make sure that, you know, this little, this big bet that I funded doesn't look like it's materializing.

29:21And so I need to make sure that I am not continuing to throw good money against a bad project. But the important part really is thinking about, have I considered multiple scenarios of what could happen? And it's not simply an optimistic scenario and a pessimistic scenario, but have I considered the different scenarios of things that could happen in combination? Sometimes positive and negative things might happen in the same scenario, but recognizing the combinations of things that could happen and identifying and planning for the actions to be able to react to accordingly. So that's a more proactive way to anticipate what might happen.

29:58And Matt mentioned earlier that when spreadsheets came out 30 years ago, everyone could then do a what-if analysis. And that was a really big step change. And now with AI, we can do much more complicated analyses much more quickly. So, Michelle, what role are you seeing AI playing in scenario planning? And in your experience in working with management teams, is there an ideal number of scenarios that they should be thinking about and planning for? I think AI does allow you to take a look at more scenarios and it does allow you to take into account more potential drivers. But I think actually the real value of AI is it helps you narrow from an infinite number of scenarios to what are the most likely scenarios that we think are going to happen and possibly continuously monitor when I am trending in a particular direction that suggests I might be moving towards one of those alternative scenarios off of my base budget.

30:51So that's actually one of the exciting things that AI has the ability to do. In terms of number of scenarios, I think most commonly, and this is what I encourage my clients not to do, most commonly I see organizations work against three scenarios. It's your base budget, an optimistic scenario, and a pessimistic scenario. And I think that that's a little overly simplified without really thinking about how many of those drivers might interact with each other. And so I actually encourage many of my clients to think about an even number of scenarios because that forces you to move away from the idea of your base scenario is that middle scenario.

31:29So the idea of four scenarios, this is not you don't need an infinite number of scenarios. But the idea of four scenarios really forces organizations to think about different combinations of how those drivers might interact. and therefore what might some of those mitigating actions need to be that they can go ahead and preemptively plan for. Thanks, Michelle. That's a great push on four scenarios rather than three. A little unintuitive, but makes a ton of sense. And Karen, maybe you can take us through an example of how you did this at Cognizant. So we did not really have AI when I was at Cognizant still, but certainly we use technology to help with that and data.

32:08And I think really understanding the key drivers of your business is the most critical part and having access to the data that supports those drivers. And now with AI, we've seen this with some clients that we've been working with recently, right? AI can really help model out how those drivers are going to interact and under the different scenarios, what might happen. And to Michelle's point, it doesn't need to just be an optimistic and a pessimistic scenario. Now it can really be a a real blending of different things that might happen. And the speed and the quality, I think, which we can do that analysis today, assuming you have good data and you understand the drivers of your business, is fundamentally different than it was even five years ago and much, much more powerful today than it was.

32:54All right. So Michelle, beyond the scenario planning and the scenarios themselves, what else do leaders need to think about to ensure resilience while also making these moves. What exactly is a resilient budget? It's a resilient budget is not just a static single point plan, right? But a resilient budget is have I actually thought about the different things that could happen, both positive and negative within the broader environment and how that might mean we need to react? Do we have the resourcing needed to be able to react to that accordingly? And can we quickly pivot if we need to shift our resourcing from something that was in the base budget to be able to fund some of those alternative scenarios?

33:36I think that the question is, have you built a resilient budget? Or in the absence of thinking about the different scenarios, might you learn the hard way? How high those opportunity costs and how high those trade-offs might have been if you weren't able to react as as quickly as a well-scenario-planned budget might allow you to do so. And Matt, anything you would add here in terms of what leaders should be focusing on around scenario planning and building resiliency into their budgets?

34:04Matthew Maloney: One of the biggest things that folks struggle with is, do you really understand the drivers of your overall enterprise today and linking those to operational drivers? And that's not thousands. Typically, there aren't that many that really, really move the needle. So they overcomplicate things or kind of throw their hands up and say, you can't possibly have this, but there is a way to do this. And so then the discussion, it's a crutch to be able to fall back upon the model and the forecast and that false sense of security that we're going to get an accuracy of a number, but the number isn't actually driving the discussion and the decisions that you need to make.

34:41Matthew Maloney: If your business is growing at a few percent a year and you want to be growing at high single digits, what are the three or four things, five things that are your big bets? What's the ROI of that? What's the investment people and capital and OPEX that are going to get you there? And how quickly can you come back to which ones are working and how can I double or triple the budget of those to spend an awful lot more to accelerate? And where would I need to prune or trim back on others? And I think at the moment right now, what happens though, is people get lost in the tale of thousands of small little pet projects versus the few that are really the big ones.

35:16Matthew Maloney: And so they actually underfund what is going to truly change the trajectory through cycle to try and manage a near-term guidepost that they've told either the sell-side analysts or their board of investors. I think that's so critical, Matt. this issue of the opportunity costs and when you don't make the big investments that you need to make in your strategic initiatives can really cost you. Not only does it place you behind where you want it to be from a competitive perspective, but I've seen situations where companies also end up having to write off massive investments because they didn't continue to make the investments they should have.

35:54So a company does a big acquisition, for example, but it needs investments to make it successful in their context, they cut back on those investments because it was COVID and geopolitical issues and so forth, right? So they're pulling back on their budgets. Next thing you know, that acquisition is no longer worth what it was worth initially. You end up with a big write-off. So now you've got a double-edged sword, right? You've got the P &L hit from the write-off and you aren't where you need it to be from a competitive perspective. So it can really be very costly to not continue to focus on your strategic initiatives and give them the funding that they that they deserve.

36:28Matthew Maloney: Yeah, I think, Karen, to that point, two things that I see often not done. One is, can you go big, but in a small way to prove something out that then scales? So give an example of, can I launch a new product or a service in a very small geography as if you were spending, say, for the full US, but it's only in one MSA? And then if it works, scale it up to the next three, four, five, et cetera, versus spending so big, it's how do you eat an elephant approach. which the other one is then is not asking for the big, bold thing because of bias or fear of asking for the big, bold thing, because then you're going to be held accountable to delivering the results on the other side.

37:08Matthew Maloney: And so sometimes there's this fear of asking for the small thing when, in fact, you need an awful lot more and the board and others are willing to back you. If it's a$50 million investment, but you really think for sure it's going to be at$60 million, ask for the$60 Because if you go to 50 and you come back and say, I need 55, sorry, you proposed this to me. You've asked me for a number. I gave you that. The incremental delta of what you need for the full, full thing to go big and bold, ask that one time versus having to keep coming back in small little bite size, right? Again, it goes back to the budgeting and the incrementality kind of mindset versus the through cycle.

37:45Matthew Maloney: If it's the right investment, if it was your company, you would go big and go do that. You wouldn't go in and say, let's go small and be cheap on what's really needed to drive. If these are the three to five big things that are going to truly change the trajectory of your business, let's go big and fail fast, as Karen mentioned. Super. So we touched on AI and its potential and scenario planning, but let's move now to that fourth imperative, which zooms in on how AI and data can really move the needle on forward-looking budgeting and decision-making. Matt? Sure. A couple things just to ground. Speaking to over 100 CFOs just in 2026, the vast majority, I would say 70 plus percent, say that the majority of their finance function spends most of their time on finding data, cleaning data, analyzing data, putting it on a static PowerPoint backward looking number, or the part that what Michelle had mentioned earlier, coming up with a incredibly granular, almost false sense of precision forecast that drives no decisions in discussion.

38:51Matthew Maloney: And so there's an incredible amount of energy being spent on things that are not actually driving the performance dialogues that you should be having on a monthly, quarterly and annual basis. And so what AI does, and oftentimes in the past, folks have used as, again, an excuse, well, I don't have the perfect ERP system. I don't have the perfect data. Those things were true to an extent when you lived in a world of automation and things where everything did have to be perfect and you had to clean up all the data and the cost was there. That is not the case anymore. And so how do you free up that amount of time?

39:26Matthew Maloney: This is not, again, 5 % or 10 % of time that's around the edges, to be able to have the numbers in your backward looking day plus one of once the controller closes the books, why can you not have everything that you needed for reporting right there in front of you? Why can't you have an agentic set of FP &A agents that you can interact with and they're interacting with the data to propose what you should be talking about and what are some scenarios that you might want to be able to discuss in midterm as well as immediately growing threats, growing issues your concerns on trends and being able to separate the signal versus the noise, right?

40:02Matthew Maloney: It's not more and more data and more and more walls of numbers, but rather, again, as Michelle mentioned earlier, how do you narrow down to the handful of things you really need to discuss? And so what AI is helping to do is kind of faster, better, and less expensive, right? Faster, meaning why can't I have this in minutes versus in weeks to redo my forecast better? How do I remove the human bias from the forecasting where the sales teams is always going to say, I'm going to over deliver and the operation team is going to say all the costs are coming in and all of a sudden that's not hitting your number versus showing them every single month that their forecast continues to be directed that way.

40:39Matthew Maloney: And oftentimes CFOs, the center led CFO and FP &A have a more accurate forecast than the business units. What does that tell you about it? Because they know how to remove the bias. And then the last piece is not only the speed, but also then the time when, yes, when you have these kind of existential questions that you need to go and raise that are not thought of or in the system itself, how you can quickly do scenario planning. It's not a, let's come up with 15 different things that we're going to go test and run a sensitivity analysis that Michelle mentioned, but rather you can do it real time in the meeting, moving around what are the operational KPIs to then drive the discussion of, no, everyone's saying there's 10 things that matter, actually two or three matter.

41:21Matthew Maloney: And what do we think is going to happen? And what of that can we actually make a decision and drive versus a macro trend that we're going to be part of the results of that trend? And so we may have to shift our business and our thinking to be able to ride through that negative trend or to capture the positive one. And so are you just managing spreadsheets and backward looking thing? Are you really driving the true decisions and discussions that you as a CFO, as well as the CEO and the broader board are yearning for on a monthly and a quarterly basis? or are you just sort of passing the time and let's do another report that's backward looking and is stale from, you know, what is the weather from yesterday?

42:00Matthew Maloney: That's not actually driving things. Right. And Matt, do you have any examples of how you've done this with clients and when they hit that aha moment when it was like, wow, this is such a better way to do this. So one of them, which I think is the, the, the biggest and easiest one to do is can, can you give me all your monthly and quarterly business reviews? And I can throw it into what we already have as a gentrified McKinsey finance experts. And I'll come back in an hour, not in days, not in weeks, and rewrite what is the discussion and dialogue with a CFO cockpit, if you will, of all of the numbers and then saying, how is this possible?

42:39Matthew Maloney: These were PDFs or these were Excel. And you didn't even tell it what it was doing. It's kind of a McKinsey in a box of sorts to be able to say, this is the art of the possible. Now, is that dashboard exactly what you need and what you want? No, but it's probably 80 % right as a starting point. And it will improve, again, speed, quality of the speed of discussions, quality of discussions, higher confidence level of things. You say, okay, now the eyes are opened. Now, where do we go from here versus no, this thing is in its kind of vaporware and science fiction, that is not the case anymore. And so being able to have that in a matter, again, of minutes versus in matters of weeks to be able to close and report how did the business drive in the last 30 days.

43:22And Karen, you mentioned that when you weren't cognizant, you didn't have all the benefits of these generative AI capabilities. But as a CFO, how would you react to what Matt just described? And are you seeing that now in the marketplace and with some of the clients that you're talking to as a senior advisor to our firm? Absolutely. It's so powerful. And it allows you as the CFO or the finance organization to have a real business conversation now with the CEO, with the business leaders, the speed and the quality and the depth of the analysis that we can get into today is just worldly different than what it would have been five, 10 years ago.

44:02And the need for the CEO and the management team to have this analysis and this data real time, right? The world is shifting so quickly that if you say they have to wait a month to do their business reviews. It's worthless at that point. And we've seen great reaction from clients that we've been working with when we show them this. And as Matt said, it doesn't have to be 100 % perfect to start with, right? This is about the art of the possible, but it is really a game changer. And I think for me, anyhow, as a CFO and for my finance organization, we loved being business partners, right? I didn't like to have people who just wanted to be spreadsheet jockeys.

44:39I was terrible at macros, frankly, myself. So Excel was never my favorite thing. But I really wanted to be a business partner and sit with our business teams and really talk about how are we going to drive the growth of the business. And these tools today allow you to do that even more than we could in the past. Thank you, Karen. And Michelle, harnessing AI and data to make budgeting more forward-looking and more responsive also may result in more and also should result in more transparency. Once you remove that information asymmetry, if you will, it can be pretty easy for the emperor not to be wearing any clothes.

45:16And I'd imagine this could cause some challenges. So how do you see your client organizations deal with that? Yeah, we sometimes work with organizations where part of the reason it takes so long for results to be able to kind of be shared at the top is because at each subsequent layer, there's a desire to be able to massage the narrative, right? And the idea of AI helping to democratize that data and be able to enable access at all levels to that data much more quickly, and ensure that there's a single source of truth. Everybody is actually looking at the same set of metrics, the same results, the same outcomes and analyses and insights at the same time, is a pretty revolutionary change for many of those organizations where, you know, no result was shared until it went through at least four layers of leaders and each of those leaders had a chance to put their spin on it.

46:05And so that's a little bit scary for organizations, in some cases a lot scary for leaders who, to your point, that you start to realize the emperor does have no clothes on. And so how do we actually change? And there are some real cultural changes that do have to exist. But I think partly it's a recognition that it's important to make sure your leaders have the same visibility to the results and the data as close to real time as possible so that we can all jointly help react to what should we be doing about it. And the time it takes to be able to massage that story through multiple layers of leadership is actually time that's wasted from allowing us to actually take action.

46:45And so I think that's partly both a messaging change as well as a cultural change, as well the process change even of setting the expectation that we're going to have those business reviews earlier in the month because we should have visibility to what's going on. And partly that's allowing us to be able to make decisions. And partly that's because we want to make sure that we are able to drive performance management and hold leaders accountable to the results that they're delivering. So do you think that there's often some level of resistance then to changing the budget approach in the ways that we've been discussing?

47:21And is there anything else that makes this uncomfortable for organizations? Absolutely. You know, I think that there's a lot of organization resistance that can happen with a lot of the changes that we've talked about today, right? So the idea of we are, in fact, challenging people who have thought my resourcing is, in fact, going to be the resourcing that I'm going to get for the next few years, right? Or the idea that I'm going to have to prioritize between two very attractive projects, one of which has a better ROI. And we simply don't have unlimited resources to be able to fund everything.

47:53And I think in many cases, it is actually going to force parts of the organization to really be able to defend how does this particular project that you're very excited about help to link to the strategy? How is this, in fact, going to help us deliver on the strategy? And so I think that there's a number of elements of just organization inertia that you do need to be able to overcome. And partly that's going to come from the right leadership communication and the right leadership role modeling around the decisions that we're making are going to enable us to make sure that we are helping to shift our resources to the places where they're going to help us deliver the best returns.

48:33And what might deliver the best return in one point in time could change, again, in the spirit of it's a dynamic environment we're operating in. And so helping the organization with the right communication, with the right role modeling, really be able to understand the reasons for those changes. And what does that mean for me? Does that necessarily mean that my part of the business is now less important than it was? It's not about importance. It's about the role that you play in the broader portfolio to help our broader organization ensure we're still working against all of our key priorities and our key goals.

49:10And Matt, earlier you talked about a kind of strategic unlock that happens when a company goes from being publicly held to private equity owned. Do you have any insights from working in private equity that might help any company leader change their budget approach and reduce maybe some of the organizational resistance to the changes that we're talking about today?

49:30Matthew Maloney: So I don't think there's a silver bullet or an easy solution here, but the thing that is radically different and transparent up front is number one, there's a clear call to action of transformation and driving in a short timeframe, a number of big, bold bets. That's number one. And that can be true in a public as well as in a private setting. Number two is the incentives are almost always very, very well aligned to driving again that overall enterprise value of the company, which is not always the case specifically for in a publicly traded company settings where they may not be very, very well aligned to driving again that multi-year through cycle decisions, right?

50:16Matthew Maloney: where a large portion of the comp for a private equity held company is based off of the equity they have in the shares. And they know that that's going to actually be realized in a very short period of time. And so anything they can do to drive that, as Michelle said, there's the budget is a guidepost and an important one to have, but really you're trying to drive year over year acceleration and value creation. I think the third one, which is a friction that always happens, But particularly, and this can happen again in a publicly traded company, is a board that's very, very engaged, understands the numbers, understands the drivers, and is there not to point fingers or I got you's with the management team, but rather to work with the management team and to give them the confidence and the courage to go after these big, bold things that are there.

51:02Matthew Maloney: And then for the management team to then transmit and cascade that same thinking throughout the whole company itself. And I would say the same is true also of quarterly reporting back to the street. I think oftentimes, you know, if you can show the long-term trajectory in the near term where you're investing and you're going to have to kind of go down slightly in your financials to go up much, much larger, investors do want that through cycle thinking that we've seen, you know, countless from our colleague, you know, Tim Kohler and things of let's not get. tied to those quarterly moments at the highest levels, right?

51:36Matthew Maloney: It's really important to kind of have as an unlock. Super. Thank you all for this great discussion. And I'd like to remind our listeners that your article also offers a really nicely packaged view of those four imperatives. And again, it's called Your Budget is Killing Your Strategy, and the link is available in the show notes. So as we close out this episode, Matt and Michelle, I was hoping that perhaps you could share what you're most excited about this research in your work with clients right now. Sure, Sean. I think it's actually grounded in some of the questions throughout the discussion today.

52:08Matthew Maloney: I mean, one, it's super exciting to actually take a step back and to say, what is your long-term strategy? And are you putting those big, bold bets and kind of locking arms with them and going down along on that journey, right? And knowing that you don't know everything, but you're making those big, bold bets. And it's not just kind of business as usual delta budget from last year. I think second is to sitting side by side and helping them make those tough decisions, the trade-offs, the prioritization or reprioritization in year, where again, helping them with confidence know that all things being equal, we've got the best information we can and we should move forward.

52:47Matthew Maloney: And then I think lastly, the piece on AI is just transforming it from, as I mentioned before, from the time that was pencil, paper, and adding machines to mainframe computers to then mainframes to, you know, Lotus Notes and Excel to now this, this is as much of a transformation from the ways of working in finance in the past to going forward. And as Michelle mentioned, there's some of those are a bit of a terrifying moment, but knowing that you need to go and do this to be able to be on the cutting edge with what our others are doing in the market to not be left behind is really exciting. Thank you, Matt.

53:21Michelle? Yeah, I'm really excited for the ability for finance organizations to spend less time preparing the budget and a lot more time actually helping influence and steer the decisions that need to be made. How do we make sure that we are actually funding the biggest strategic priorities that are going to help create impact for the organization? And so I hope our audience will really take away the idea that it's so important to really be able to link your budget to strategy, really be able to help reallocate resources across the enterprise. Using those different scenarios that we talked about will be particularly important for us to be able to get there.

53:55And there's so much potential for AI, I think, as we think about how your budget can better deliver against your strategy to really be able to unlock the insights that you need to make sure your resources are put against the right bets. Matt, Michelle, Karen, thank you so much for the time today. We really appreciate it. Thank you, Sean. And thank you to all of our listeners for joining us today. We hope you enjoyed the conversation and we welcome your feedback and ideas for future episodes. Our email is itsr at mckenzie.com. You can also share your ratings and reviews on any podcast player with many thanks to all who've already done so.

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