Managing Discretionary Spending and Pensions

Companies generate funds for investments from various sources. These investments are again allocated to various purposes, such as business expansion, for improving processes, for purchasing new businesses, or what have you.

When you invest in a new business, you usually track the revenue generation or the new business that it has generated and if it has not brought in anything near what you originally thought it would, then you re-evaluate it and then leave it or digest it.

Investments can be measured easily by revenues or costs, but when one is talking about operational changes, technology investments, purchase or implementation of patents and other intellectual property or say buildings, it suddenly becomes extremely tough to evaluate whether your investments are doing well. 

Here, I try to shed some light on how one can help manage discretionary investments.

In my short experience, I was continuously surprised at how lazy people are in terms of managing their investments, in other words their capital. I asked the same question when I was at a conference some months ago, namely how many people actively check their internal firm investments in the same manner they do their pension fund investments? Hardly any hands went up in the hall, where numerous senior managers were sitting. This is why so many firms have less than efficient internal investments.

Portfolio management has existed for many decades, since Harry Markowitz proposed his portfolio management theory way back in 1952 (here’s something for the conspiracy theorists, his major work was done in the RAND Corporation…). Since then, three generations of investment managers have grown up and applied the principles of portfolio management to their investments. Portfolio Management is applicable to any form of investments and the basic concepts are the same: diversify your investments, make sure you know what you are investing in, the effective and efficient capacity to disinvest is more important than to invest, the objectives for the overall portfolio might be different from the sub-component objectives, do regular reviews of your investment and finally, be as transparent as possible, etc.

What do you do with your investments in your pension funds? You check them regularly, no? You invest in your pension with the expectation of future gain or benefits.

Depending on your personal circumstances, you decide your investment profile and target areas and then monitor the risk-return profile regularly, you replace badly performing funds with better performing funds if required, etc. In other words, you do Portfolio Management. And frankly, that is what you do within firms as well. Or rather, this is what you should do. This relates mainly to financial institutions, although the concept will apply equally to any firm.

The support areas within the companies also invest, but not in bonds or shares. Instead, they invest a certain discretionary sum in technology, in improving and running those processes, in offshoring and outsourcing, in satisfying regulatory and compliance demands, in revenue generation activities, in setting up branch offices, etc. By their very name and nature of being support areas, they provide some business benefit, either by allowing us to operate as a firm, or reducing cost or satisfying regulatory requirements or increasing revenue or a combination of some or all of them.

In a firm, there are two types of spending: "Business as Usual" versus "Discretionary" spending. The former relates to the spending you have to do to support your existing business, while the latter relates to “new” spending, designed to support growth and explore new opportunities. This second type is that which we would call investment.

Bearing this definition in mind, there are some key questions to consider. For instance: Do you analyse your discretionary spending for suitability? Do you know what you are spending the money on? Do you check whether it is providing value? Do you stop investments? Can you respond to ad hoc information requests from the business on the return on investment footprint for the investments? Often, the answer is "no." So, if you do that analysis with your own pension, why not do so with your technology or operations investment? And if you wanted to do so, what do you do?

The level to which you will go to analyse your investments obviously depends on the size of the firm, how you run your financial systems, what kind of financial governance do you impose internally etc. But for a large global financial institution, what you do is to get a small team of senior chaps together and get initial agreement on what you want to achieve, what will be the methodology, logistics and how will this portfolio management function be governed.

The data you need is simple, such as the name of the programme or project or investment, start and end dates of the projects, which business unit is paying for it, which unit will be involved in the implementation, the status of the spend (committed, authorised, approved, spent…), the purpose of that investment (regulatory, revenue generation, enhancements…), when the benefits will arise and so on.

Don’t complicate matters, a simple Excel spreadsheet is just fine. There is much benefit in keeping things simple but mind you, it would be worthwhile to invest in some good technical expertise in reports, graphs and business intelligence to present the data. But I am getting ahead of myself.

There are two problems which are crucial to manage. The first is the process to get the data and the second is the data itself. Senior management engagement is vital for this, but then, anything of this nature will require senior management engagement anyway. If you don’t have senior management approval and push, then you might as well stop, because your life will be hell.

Nobody likes their spending to be made transparent and if you do not have backing, you will get trashed, ignored or worse, actively banned. You see, transparency means performance matching. If your head of operations has $10 million to invest, the business can legitimately ask him, where are you spending that money and how do you justify that investment? Also, show your productivity gains (as in return on investment…).

But if transparency is not achieved, then the head of operations can merrily go about spending money without any care for performance or improvement. Even if they are all above board, how do you know where the money is going? Is it going into unproductive causes? How much is left in the kitty? How much of the money is tied up on multi-year spending?

To answer all those questions, senior management support is vital.

Senior management cannot, by themselves, sit in on every meeting with the spending divisions. This requires the second solution, and that is to have relationship managers. Whether you are doing this at the technology level, the operational level, the business unit level or whichever level you are aiming at, you need senior relationship managers who can talk to the business managers at their level of expertise and experience. If you do not have serious relationship managers who can understand the spend patterns, the business that is being supported etc., the process and data will not be good. In other words, you cannot have a fixed income trading background relationship manager talking about investments with the chief infrastructure officer, they simply cannot relate to each other.

The third solution is to invest an indecently huge amount of time and money in the pre-training, communications, workshops, conference calls, etc. BEFORE the process starts off.

This portfolio management process has the capacity to seriously influence your entire organisation, from top to bottom, from trading to procurement, from regulatory reporting to market data. So, before you actually kick this process off, make sure you have talked, discussed, debated, argued with as many stakeholders as possible and then document the agreements and then talk, discuss, debate and argue again. It is easy to go wrong once underway and difficult to change direction when started, so front load all the push, training, motivation, and discussions.

Then come the data challenges. Even though you have a good simple data model, you will be surprised how difficult it is to get the data. Simple concepts become horrendously complicated when seen across national boundaries, cultures, ages, sexes, languages, charts of accounts, etc. For example, a simple question like, what is the difference between a programme and a project becomes exceedingly complicated (Go for a more than 10 million budget as an example, and it’s a programme with sub-projects, and anything below 100 K has to be a task which has to be rolled up into a project).

What do you mean by project / investment start? Does start mean that some steering committee somewhere has given the go-ahead or the capital allocation committee has said, yes or the CFO has signed off or the money has actually been transferred to your cost code? Or does it just mean the project / programme initiation document has been signed?

A data dictionary should be written and training has to be given. Regular training, communications, etc. should be the lot of relationship managers. One has to beware that this portfolio management process might conflict with local financial governance, so having a word with the local or functional CFO before rolling this out would be better. For example, the standardisation of the “start” of a project across the globe and all units could require all CFOs to adopt the same sort of financial governance in terms of signing off and transference of funds to cost codes. So, keep it simple. Remember what Einstein said, "everything should be made as simple as possible, but not simpler."

Once the data starts rolling in, then get your business analysts and reporting gurus to work on it. A short, sharp presentation with some smart graphics showing the spending, its type and shape etc. is great, but add commentary to this analysis.

If you find that 40% of your funds are spent on regulatory aspects, which are multiyear in nature, consider asking the business COO and / or the CFO to ring-fence those sums into an SIV or in special codes which do not belong to the business or function.

This has huge advantages.

You do not have the temptation to dip into that pot. That pot of money is not something that you can influence, so you concentrate on value additive aspects of your investments, etc. It’s like the difference between spending your money on electricity versus spending your money on an iPod. Over the course of a year, both amounts would be the same, but you manage each investment differently and the same goes for mandatory spending.

Analyse when spending happens. The number of times I have seen people forget the yearly cycle is amazing. Spending behaviour changes over the year. The months just before accounting closes change as vendors and clients change behaviour, so that costs/revenues hit their books differently. People forget there is something called committed spending, especially in these days of outsourcing and offshoring. So if you want to cut costs, it is not that simple. If you were planning to put in gated funding, it does not work properly with outsourcing contracts. So commentary around that will help.

If you can get figures for return on investment, then there is nothing like it. That will make you the darling of the firm. You can turn around and ask (well, request…) the business owners: “You invested 100 million in that business, show that it returned the funds you said it would in the business case.” This commentary and visibility on the numbers is absolutely golden for senior management.

So what do you end up having? You have a process providing you with investment information which ends up giving management information on the investments. Now what?

Well, now you use this information in various management areas. Budgeting should be one. Performance evaluation should be another. Cash flow planning is another area where this can be used. Human Resource planning is an area begging for good portfolio resource planning. Across the firm, you will have very few good change managers and on the back of this process, you can hang a strategic resource plan. This structure also allows you to make investment changes with the greatest efficiency. This takes the emotion out of decision-making. If you have to cut your costs, then you can home into the areas where they are exactly possible, rather than areas where people “think” and “emotionally” believe costs can be cut. That is not good for the firm.

This structure also allows you to re-jig investments. If a strategic project is overrunning, then this structure and data allows you to make unemotional scientific decisions to take money from another project and give it to the project which is running a shortfall. Another advantage of this process is that it forces the entire firm to start talking the same language. Never underestimate the benefit of the firm using the same functional language and this is very useful indeed.

Think about it, your mergers and acquisitions will go much more smoothly if you have a clear-cut way to handle investments, both the old and new employees are clear about their business functions and their future. Again, the emotion is removed from the argument.

One way to get the language part right is to use a methodology. No point in hiring expensive consultants to tell you how to run your business.

Industry firms such as HP, IBM, Accenture and other firms release pretty good white papers on project portfolio management. If you want to go for a good book, then select this one by Shan Rajegopal, Philip McGuin and James Waller, titled Project Portfolio Management (ISBN:0-230-50716-6, Palgrave MacMillian). The book comes highly recommended and is written by authors who have obviously implemented project portfolio management.

They have written an excellent manual based on their experience with their clients. The only couple of criticisms one might have with the book is that they do not consider discretionary spending more widely, but rather take a perspective of technology spending only. However, that complaint is perhaps unique to Banking and Financial Services compared to other industries. Second, some more case studies might have been useful, but I suspect this kind of data would be very difficult to get. Still, you can do much worse than to keep this book on your reference shelf.

It is not an easy exercise. It needs much senior management attention and support, months and quarters of work and talk. You need to overcome a lot of cynicism and you have to work against the inertia of rest.

At end of the day, the data that you will get will be rich and will definitely be worth it. Don’t think that this is only for senior management; this can be done by any manager in charge of investments.

How do you know if you have done your job of portfolio management well? If your presentation to your management is received by raised eyebrows and the sentence, “This is interesting”, then you know that you have done a good job of it. But treat your investments as you would treat your pension, and your future life will be much safer, smoother and exciting.

All this to be taken with a grain of piquant salt!