Resource Allocation - Big Businesses Do It, So Can You

From the article: How to put your money where your strategy is, by Stephen Hall, Dan Lovallo, and Reinier Musters, McKinsey Quarterly,  March  2012.

Allocate resources for growth using methodical and structured investing. 

Big business can be a role model for small businesses, but modified scaling is critical and understandably important and sticky. Use the principles for a broad stroke application and define your own triggers.

How do Chief Officers, the Board of Directors, and management assess corporate resource allocation patterns? This is a major challenge for most conglomerates and multi-business companies. 

Using a framework of decisions and well defined parameters, your small business can adapt and grow using a policy of change using similar guidelines. 

A successful business depends heavily on management's ability to define goals and set limits for the company. Decision rules and organizational processes remove ambiguity and set boundaries. Many CFO's view this approach as an investment policy for corporate growth. The pressure for corporations to increase returns on departments or sales channels year after year continues to increase dramatically as companies, large and small, become more agile. This ability to make changes, shift directions, and adapt quickly to new environments while serving smaller markets is the niche, it is the new norm for success.

Why do companies struggle with resource allocation?

There are many reasons companies struggle with resource allocation. The McKinsey article focuses on two areas believed to be key in limiting allocation optimization. One revolves around behavioral finance while the other dwells in human nature.

1) Behavioral finance covers the reasoning investors and business owners use to act on decisions involving investments. Thought patterns refer to anchoring and relying on benchmarks that are relative, not absolute measures.  Often this involves a not-so-rational decision making process. For example, an investor might focus on the price they paid for the stock as a measure of relative value, though value is intrinsic and contains volatility, it is not an absolute assessment going forward. 

2) The second aspect thru human nature refers to political ties and the social norms of hierarchy. In a large corporation, division heads and leaders are highly competitive and do not willingly give their share of available resources away to departments outside their control. While thinking patterns are natural and politics are social, they can both create a resistance to change and an atmosphere of 'starvination' in the corporate world. 

If the once leading product channel in a conglomerate receives the majority of marketing funds year after year while their sales shrink, the corporation is losing opportunities by putting the same proportion of cash into a dying product chain when this cash could be funding future products with a stronger growth potential.

McKinsey researchers reveal 4 ways to overcome these obstacles.

The authors know the company has two choices: a) either the company changes itself, or b) the market does it for them. How many companies do you know got locked in behind the curve of progress, looking for ways to catch up to a world in rapid transition? AOL and Yahoo are two.

For long-term growth and not short-term profits: 

  "The goal isn't to make dramatic changes every year but to reallocate resources   

   consistently over the medium to long-term in service of a clear corporate strategy.”

1) One way to avoid cognitive roadblocks is to pursue an active allocation agenda, similar to portfolio management. The authors refer to this as a 'target corporate portfolio' and indicate that resources should be re-allocated over time as determined by the projects that increase return on investment. Corporations should follow their capital expenditure instincts by making the process a part of the long term strategy for the company. They cite Google as a great example of a company that has done this very well at a 20% resource level. I'm sure many of you who have come to know Google are familiar with this strategy. If you are interested see: Google’s CFO on growth, capital structure, and leadership.  

Generally, a company’s industry is not as important so long as the company consistently follows and adjusts to the shift in returns on invested capital. Being flexible and having room for options is the key.

Why do corporate leaders and small business owners hesitate to follow changes in their strategy? 

The study attributes resistance to change to the psychological effects of anchoring and loss aversion, .
  "When it comes to avoiding anchoring, there's no substitute for rigorous critical thinking." *   Why, why, why? The subject of behavioral finance is rooted deep in the mind.

2) In order to survive, small business owners must use all of the resource allocation tools available.
There are four fundamentals of allocation: 

            1) Seeding

            2) Nurturing

            3) Pruning

            4) Harvesting 

I think these are fairly self-explanatory but realize the flexibility in each as they pertain to your business. As a gardener, I know something about tomatoes, peppers, beans, and squash. I know each plant has it's own unique needs. Seeds emerge at different times in the growing season. They need different nutrients and have their own strengths and weaknesses, much like my small business.

3) Use simple rules to make changes, break the status quo. Having rules in place takes the ambiguity out of the discussion and makes decisions easier. 

Uncertainty becomes a 'how to' and not a 'should we', eliminating doubt and saving time. When a company can systematically make improvements a regular event they win. This slides right into #4.

4) Implement the process of strengthening allocations. Again, make the process of deciding where to put the resources the next step in your plan. Cliches are passe but, use your map and if there is a traffic jam, don't waste time deciding if you should look for an alternative route, find a better alternative. Go, man, go! 

Discover ways to overcome inertia and join main street. By using a road map for your business or following a targeted corporate portfolio, you can adopt the implements of change.  Companies should identify generic strategies as a means to point the company in the right direction and learn to use industry peers for insight as to what changes are taking place in your industry.

Increase your company’s value! 

Set a Strategic Company Resource Allocation Plan (SCRAP), If it's not Strategic it's (CRAP).

*http://www.investopedia.com/university/behavioral_finance/behavioral4.asp

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