Strategy & Corporate Finance Practice

Admit it, your

investments are stuck
in neutral
New research shows that companies that know how to shift critical
resources where and when they’re needed share common traits.
Rigor is the first one.

by Massimo Garbuio, Tim Koller, and Zane Williams

© z_wei/Getty Images

June 2019
 Studies show that companies that actively reallo- processes and project cycles in sync; and they
cate resources outperform those that don’t.1 In recognize the importance of offering incentives that
many companies, however, a range of obstacles— encourage managers to move critical resources
cognitive biases and inconsistent decision-making where they’re needed, when they’re needed.
processes, for example—keep planning teams
and senior executives from being as “active” as they
could be. As a result, when executives are faced How to be rigorous and flexible
with opportunities outside of the traditional budget- One of the main themes we heard from survey
ing cycle, they can get caught flat-footed.2 respondents is that having the right kinds
of processes for making investment decisions is
Pervasive as this problem is, it can be overcome. important—not just for clarifying who has the
Our research on how companies make investment power to propose new projects but also to monitor
decisions (capital expenditures, marketing and how flexible the allocation of resources is over
sales, R&D, and the like) suggests there are tangible the course of a year or a project. Here are some
ways to get better at promptly reallocating of the more common processes these com-
resources when the need arises. panies follow:

We surveyed executives in more than 500 distinct Pushing decisions down in the organization.
companies across a range of industries. We A telecommunications equipment manufacturer
asked them 35 questions about their investment gave business units in some locations leeway
and decision-making practices, as well as in making investment decisions: they had “universal”
managers’ appetite for taking risks and the incen- targets for revenues and margins, same as every-
tives that were present in their companies. We one, but they also had freedom to invest and make
identified common traits in these companies, and trade-offs as needed to hit targets at the local
we used cluster and regression analyses to level. The only rule was that those additional invest-
quantify the impact of those traits on companies’ ments needed to be signed off by the business-unit
performance generally and on their growth head and the finance head. Some of the local
and innovation more specifically. We supplemented business units used a rolling 18-month performance
those data with 16 in-depth interviews with a forecast to ease this process. The forecast
subset of respondents. allowed them to understand trade-offs and model
the implications of potential actions in real time.
As we looked more closely at the outperformers in
our data set—or, the companies that actively Minimizing the number of meetings and decision
reallocated resources within their portfolios—three makers. Several of the executives we interviewed
traits kept turning up: agility, a commitment to said they held only two or three meetings to
project discipline, and a higher-than-normal review a project proposal and typically designated
tolerance for taking risks (see sidebar, “The three only two to four people, on average, to formally
characteristics of active reallocators”). approve a project. These companies did not want
to court recklessness, however, so they also
Follow-up conversations with the most active implemented clear, consistently applied criteria for
reallocators revealed that when it comes to how projects should be evaluated. Executives
organizing operations, they appear to do two things know in advance what to include in their investment
particularly well: they are simultaneously proposals, what metrics they should present,
rigorous and flexible, keeping decision-making and how to defend their proposal to decision makers

1
Mark De Jong, Nathan Marston, and Erik Roth, “The eight essentials of innovation performance,” McKinsey Quarterly, April 2015,
McKinsey.com; see also Stephen Hall, Dan Lovallo, and Reinier Musters, “How to put your money where your strategy is,” McKinsey Quarterly,
March 2012, McKinsey.com.
2
Ronald Klingebiel and Christian Rammer, “Resource allocation strategy for innovation portfolio management,” Strategic Management Journal,
February 2014, Volume 35, Number 2; see also Andy Dong, Massimo Garbuio, and Dan Lovallo, “Generative sensing: A design perspective on the
microfoundations of sensing capabilities, California Management Review, August 2016, Volume 58, Number 4, pp. 97–117.

2 Admit it, your investments are stuck in neutral

 The three characteristics of active reallocators

Our data and conversations with exec- Project discipline. The idea that a visionary tend to establish cultures and reward
utives in the field reveal that the companies CEO or CFO can decide to bet every- systems that make it safe for employees to
that actively reallocate resources tend thing on some disruptive new technology is explore projects that may or may not be
to excel in three main areas. enticing, but that’s not what happens that far afield from the current business—
in most organizations. In our experience, identifying new ways of serving existing
Agility. Active reallocation of resources most of the companies that are active customers, for instance, or new customers
requires managers to be systematic about reallocators have specific metrics in place and new geographies. They provide
their pursuit of opportunities outside the that everyone understands up front. training and well-defined career paths for
traditional annual capital-budgeting cycle. They consider a range of potential out- project managers. And the rewards
This means adding to (or subtracting from) comes or scenarios for a given project for substantial successes include both
investment budgets during the year so and welcome input from all organizational financial incentives and job promotions.
managers can allocate extra cash to fund functions no matter what the project
new projects as they arise—and so man- is about.
agers can accelerate the timeline or expand
the scale of projects that are doing better Risk tolerance and incentives. Many of
than expected, even if this increases costs.1 the companies that are active reallocators

1
A nother survey of more than 2,000 executives found that a large proportion of strategic decisions takes place outside the annual planning process, either because the
decisions are prompted by external factors or because there is no formal annual process. See “How companies make good decisions: McKinsey Global Survey results,”
January 2009, McKinsey.com

without a ton of unnecessary back-and-forth. One affected if resources were pulled from, say, a solid
oil and gas company wanted to minimize politics but stagnant product line and shifted to newer,
in its decision making, so it does not allow business- emerging initiatives. By positioning marketing and
unit heads in the room when allocations are made. design executives as part owners of the proposal,
Written proposals are submitted and only the CEO, rather than just reviewers or evaluators, the
CFO, and head of technology meet to review company was able to identify and handle issues
requirements and decide on resource allocation. early in the process, eliminating errors or the
need for rework.
Encouraging cross-functional collaboration. One
consumer-products company made sure that Setting clear strategic goals. Project teams need
marketing and design executives were primary to understand the boundaries within which smaller
contributors to resource-related decisions, decisions can be made more rapidly. Executives
alongside business-development, finance, and in a hospital company, for instance, maintain demand
other leaders. The senior team understood forecasts for medical services offered in the
that marketing and design leaders’ perspectives different locations in which it operates. The company
(at both the early and end stages of product uses these forecasts to identify potential areas
development) were just as critical as any others’ for for expansion. Its finance function also maintains a
understanding how business strategy could be 15-year cash-flow forecast, so the company can

Admit it, your investments are stuck in neutral 3

 readily determine how many projects it can fund at set of performance criteria without noting the prior
any given time. These two forecasts have enabled year’s budget. The criteria included market
the company to respond quickly when opportunities size, potential market-share growth, and sales-
arise. When it was offered a commercial office force head count relative to competitors. Using
building by a distressed seller, executives knew in those criteria, the company built a predictive
less than a day that they had the funding and model to answer the question, “If you did not know
that the location was a desirable one for the company. what your sales targets were this year, and were
This accelerated the subsequent due-diligence relying only on the criteria you defined, what would
process, as the COO and CFO jointly prepared be the targets for next year?” It then positioned
proposals that were quickly reviewed and approved that model as a new anchor—using the results not
by the board. to make decisions but to challenge status
quo investments. This new process changed the
Prototyping new ideas. Several respondents dynamics of the budgeting discussions: the
mentioned the importance of casting a wide net for team was encouraged to ask “why?” about every
ideas and frequently testing new concepts with line item, instead of “why not?”
customers. Some even require project sponsors to
submit variations of a project idea (a different size Considering budgets to be rolling, not fixed.
or scope, for instance) alongside original proposals. Many of the executives we spoke with said they
Executives at one telecommunications-equipment consider the annual budgeting cycle to be
company routinely assign technical and sales too slow; instead they add spending to the capital
staffers to work at customer sites for long periods, budget throughout the year, so they can act
so they can better understand customers’ needs quickly when markets shift. When executives at
and share with the home office real-time one advertising agency were presented with
observations about what’s working and what isn’t. a new market opportunity, they were encouraged
Using this information, the home office has to pursue it even though it would lower the
been able to identify emerging trends sooner than company’s margin for the current year. Instead of
competitors did. Over time, the company has being penalized, the team was simply asked
been able to significantly increase the number of to revise its revenue and margin forecasts as the
new systems it is designing and selling. project progressed. This process allowed the
ad agency to adapt to technology changes in the
Removing budget anchors. To avoid rubber- market more rapidly than peers did.
stamping the same allocations year after year, one
large luxury-goods company instituted a Killing underperforming projects. Several of the
reanchoring procedure. It defined a fact-based managers we interviewed cited the need to set

Many executives we spoke with said they

regard the annual budgeting cycle
as too slow; they add spending to the
capital budget throughout the year.

4 Admit it, your investments are stuck in neutral

the ground rules for early termination, and reported However, the lack of nonfinancial incentives
the use of contingent road maps and other tools and associated with this initiative eventually proved to
approaches to achieve this goal. Managers agree be problematic. The roles on the EMR imple-
up front on specific project milestones and specific mentation team for IT and medical professionals
metrics for evaluating progress—for instance, were designated as temporary, and those
did it meet thresholds for growth or profitability? that moved to the project team had their old jobs
When such targets aren’t met, they wind down backfilled. It was unclear what career path they
projects quickly and reallocate resources to more would return to after the project. As a result, many of
promising ones. In these companies, the burden the more experienced and skilled IT staff avoided
of proof is on the business units to prove that working on the project, leaving the implementation
a project should continue rather than just assume team shorthanded in certain skill areas.
that it should.
Some of the managers we spoke with also cited
the importance of establishing incentives to take
Establishing the right incentives risks and innovate. One software company
Having the right kinds of processes for investment convenes a committee of midlevel executives each
decision making is important, but our experience year from different parts of the organization—
suggests they will fail if companies’ incentive struc- managers charged with gathering ideas for new
tures do not reward risk taking. Ideas will suffocate products and features. The committee members
on the front line before they can even be considered. pool, refine, and share the ideas with a group
of senior executives who further refine them and
Many of the executives we interviewed said they use develop proposals. The proposals are then sent
financial and noncompensation incentives to to the executive committee for debate and approval.
make it safer for employees to support potentially Once the process is complete, successful ideas
risky investment decisions. Having a good are sent back to the business units for execution—
balance of both is critical: one hospital chain was essentially completing the circle.
installing a new electronic-medical-records
(EMR) system. Senior leaders said employees’
bonuses and other longer-term performance-
based compensation would be tied to this particular Executives need to see and fund the most promis-
project’s success, not the company’s success. ing investment opportunities at any time, no matter
And the technology partner in the project agreed to where in the organization they originate. The
send out interim status reports to the hospital best practices shared here can help them do just
CEO and other senior executives, assigning letter that. With the right processes and incentives in
grades to various stages of the implementation place, managers at all levels will be better positioned
and calling out specific roadblocks and challenges to feed senior executives the innovative ideas
for the project. The financial incentives and and proposals needed to fundamentally transform
performance-tracking mechanisms were clear. The their organizations as technologies and market
idea was to make team members feel fully trends change.
accountable for keeping the project on track—not
an insignificant matter for an initiative that was
likely to cost $1 billion over ten years.

Tim Koller (Tim_Koller@McKinsey.com) is a partner in McKinsey’s Stamford office, and Zane Williams (Zane_Williams@
McKinsey.com) is a senior expert in the New York office. Massimo Garbuio is a senior lecturer at the University of Sydney
Business School.

The authors wish to thank Dan Lovallo for his contributions to this article.

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Admit it, your investments are stuck in neutral 5