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Capital Reinvestment: Balanced Decision-Making


Published in the Houston Business Journal in August, 2003.


Authors:
Osama I. Mikhail, PhD, Chief Strategic Officer, St. Luke's Episcopal Health System.
Ravi Kathuria, President, Cohegic Corporation


Mikhail

Kathuria

Where to reinvest available capital? For organizations that have capital available, where they decide to reinvest is crucial since capital invested in assets today must become a source for the future generation of capital. Without continual rejuvenation of capital an organization cannot fund its survival (defensive) and “thrival” (offensive) initiatives. Where to reinvest, is a recurring challenge as internal operations, asset divestitures and external sources continuously contribute to available capital. Which leads to the next question, how to consistently ensure the effectiveness of reinvestment decisions? Unlike operating expense related projects, capital projects generally have longer-term implications and are more difficult to unwind. Effective reinvestment of capital requires a decision-making process that engages the functions of Strategic Planning, Finance and Operations evenly and applies their evaluation criteria in a balanced way.


Unbalanced Decision-Making

Strategic, financial and operational criteria drive reinvestment decisions. However, often only one of these three criteria tends to dominate the decision-making process leading to reinvestment decisions that may compromise the longer-term performance of the organization. For example, pursuing a project that satisfies the financial criteria by promising a high return-on-investment (ROI) could be a bad decision if it distracts the organization from its strategic priorities. A strategy-driven project to enter a new line of business may fail to produce results if operations lacks the requisite skills and competencies. An operations-driven project to enhance product/service features may be a wasted effort if the customers see little value relative to the incremental price associated with the new features.

What prevents a balanced application of the strategic, financial and operational criteria? Capital reinvestment projects are often proposed and approved within a single organizational function such as Strategic Planning, Operations or Finance. Other organizational functions are involved only on a peripheral basis, leading to the evaluation of reinvestment decisions based on a single function's perspectives and analytical methodologies. Perspectives and performance expectations of Finance, Operations and Strategic Planning are very different from each other. Finance is interested in optimizing costs, ensuring return on capital, managing risk and improving earnings predictability. Strategic planning is interested in competitive positioning, market penetration and growth, while Operations (Sales, Marketing, Engineering, Manufacturing to HR, IT) is interested in efficiency, productivity and quality.

What prevents organizational functions from working together to evaluate projects in a balanced way? Internal politics, lack of interest in working together and no persistent requirement for joint evaluations lead functions to make decisions independently. In many organizations, depending on their history, culture and industry, one function enjoys dominance. This dominance makes it even more difficult to develop balanced solutions. The current mood of the organization and industry fads also lead to ineffective and myopic decision-making.


Balanced Decision-Making

A disciplined process that balances all the three criteria - alignment with strategic priorities, operational feasibility and financial viability, must drive capital reinvestment decisions. Does Operations have the capability and capacity to implement the project and deliver results? Does the project meet the financial requirements such as ROI and appropriate risk profile? Is the project aligned with the organization's strategic priorities and will it help advance the strategy? The balanced approach of evaluating project ideas against all three criteria leads to more robust capital reinvestment decisions.

The balanced approach must apply to projects not only during the approval phase but also during the proposal phase. Proposals must iteratively apply the three criteria as filters. Changing proposal parameters to comply with one of the filters must require a quick reevaluation against the other two filters as well. This prevents a proposal from going down a path where it could end up violating the other criteria. Applying the three filters iteratively during the proposal phase strengthens proposals and results in shorter approval cycles.

The organizational mechanism for applying the three criteria and ensuring a balanced reinvestment decision starts with the formation of a cross-functional team represented by the three functions of Strategic Planning, Finance and Operations. The Chief Operating Officer (COO), Chief Financial Officer (CFO) and the Chief Strategic Officer (CSO) must provide final project approval based on the collective analysis and recommendations of this cross-functional team. Concurrence of the COO, CFO and CSO must be required for final approval, which effectively gives veto power to any of the three executives and assures a balanced consideration for capital projects. Leveling the playing field by balancing the influence of the three functions leads to the most effective capital reinvestment decisions for the organization. While the “level playing field” concept may seem simple and possibly obvious, it is surprising how many organizations have either not implemented it or fail to successfully sustain it.