THE WINNERS CIRCLE
The CFOs of Cisco and Alcoa are among the winners of CFO's 2000 Excellence Awards in the US. Here's why.

Larry Carter
Category: Implementing Best Practices in Finance
By Abe De Ramos

Larry Carter won't stop to declare victory. Sometime in the past year, Cisco Systems finance organization - arguably the most efficient in the world - achieved its much-touted aim of a "virtual close". On any given workday, the California-based Internet networking company can now produce consolidated financial data and balance sheets by about 2 p.m. It has been two years since it has had any adjusted entries close the following day.

Cisco's senior vice-president and CFO can't pinpoint exactly when the virtual close crossed over from goal to reality. "This is an ongoing process, where you are always making improvements," says Carter - and a process that is far from finished. "There are so many other aspects besides just getting the monthly books done. I don't think you've seen anything yet," he continues, seeming almost to play down one of the proudest accomplishments of his finance department.

Indeed, he considers the "close" part of the phrase something of a misnomer; the process is actually most valuable to Cisco for the way it opens a world of real-time company information for use throughout the workforce. The same systems that feed the ledger also provide Cisco executives with the data they need to react to lightning-fast business changes in the Internet world. That means the totals on bookings, revenue, discounts, margins and order status are available on a daily basis. "Even when I get the [close] numbers, I already know what the answer is because we have been monitoring it all along," the CFO notes. And that makes Carter a more valuable source outside the company, as well.

"To me, as an analyst, Larry's ability to drill down and see the productivity of the week by product, by region or by account is actually more valuable than the virtual close," says Martin Pyykkonen, an analyst with CIBC World Markets. "It gives me confidence in Cisco's ability to actively manage the product and sales pipeline - almost in real time." And the abundance of data has helped Cisco achieve other breakthroughs in recent months, including a nearly 50 percent reduction in the time it takes to collect past-due invoice payments, to just over 30 days.

That range of accomplishments earned the 57-year-old Carter the 2000 CFO Excellence Award for Implementing Best Practices in Finance in the US, making him the first two-time winner in the category.

A Virtual Revelation

The idea of a virtual close was not fully formed when Carter, a 19-year veteran of Motorola joined Cisco in 1995. Instead, he wanted to reduce Cisco's 14-day close to one day - something Motorola had achieved - while cutting costs in half.

Carter could see that his new employer was facing massive growth, which could be very hard to handle with such slow financial systems in place. "I was concerned about the timeliness and integrity of our overall financial information," he recalls. "If you have a 14-day close at a company like Cisco - which even five years ago had the opportunity to grow pretty rapidly - you can spin out of control."

He was certainly right about the growth. The company has experienced a 56 percent annual compounded climb in revenues in the past five years, during which time it acquired 68 companies. But Carter takes pride in having prepared for a range of other possible problems that might result from that growth. And he credits his preparedness in part to his experience with Motorola's Six Sigma quality improvement program, which that company applied not only to manufacturing, but also to each functional group in the company.

"The close process in a finance group is akin to manufacturing," he says. "Anyone in manufacturing will tell you if you reduce the cycle time to manufacture a product, good things happen. Costs go down, inventory goes down, productivity improves, and quality goes up."

With this view in mind, Carter set to work reengineering many of the financial processes at Cisco and compressing their cycle times. Wherever possible, he used the web to automate transactions, pushing the finance organization toward that one-day close.

Then, in 1997, Carter had a revelation. "Because of the nature of the web, transactions were being downloaded to our ledger virtually every day," he recalls. "Suddenly, it dawned on me that by having this information, selecting the right metrics, and making sure they were in the management reporting system, we could change the way we ran the company."

Untouched Orders

With up-to-the-minute information available to executives worldwide, there is little danger of a Cisco spinout these days. But Carter is also careful to avoid information overload. "We try to be very selective and precise on the metrics that we need to run the company," he says. That means that data on market share, for example, is pulled only once a quarter, while revenues and margins are available daily. "Could I get EPS every day?" he asks. "Sure. But would it be useful? Probably not."

This past year, Carter extended many of the applications used by senior management to other managers throughout the company. The status of orders, for example, is available hourly to the company's far-flung sales force. "I want our sales teams and managers around the world to know where they are at any point in time," says Carter. That allows for speedy reaction to market changes, whether caused by a single customer or an entire continent. "If we have one region that is slowing down," he says, "we could start to increase resources somewhere else to pick up the difference."

If anything, Cisco's back office is even more automated. More than 85 percent of orders arrive via the Internet, and half of those are never touched by a Cisco employee. Rather, they are automatically farmed out to subcontractors, who ship finished products directly to customers. "The only thing I have to do is collect the money," says Carter. Not for long, though. A new initiative would also automate invoice and collections using electronic data interchange.

Even without that system, Carter's team has reduced its days sales outstanding (DSO) average from 60 days in late 1998 to 32 days by end-1999, nearly a 50 percent reduction. While the number has recently crept up to 36 days, it is still well below Carter's goal. "Anything below 50 days is pretty good," he says. "Companies with very high DSOs usually are not linear."

Everybody's Talking

Maintaining a linear revenue profile is a top priority for Carter. Cisco's record of meeting or exceeding Wall Street's expectations for 40 straight quarters has caused some analysts to grumble about managed earnings. "It's about managing your business, not earnings," responds Carter. "If you're nonlinear, you'll have excess capacity, people and inventory, and at the end of the day you will probably miss on Wall Street."

Carter also keeps a tight rein on expenses. Head count - one clear measure of Cisco's growth - represents half of Cisco's cost structure. Even though the company plans to hire 4,500 people worldwide this quarter, "I still approve every requisition in the company for head count," he says.

Perhaps an even better indicator of Cisco's best practices, however, is the time Carter spends talking with customers - primarily CEOs and CFOs - often discussing the virtual close and other finance accomplishments. He calculates that 30 to 40 percent of his time is spent in such conversations. "In the last six months," he says, "I have personally talked to 400-plus CFOs or finance directors around the world."

Of course, there's a self-serving element to this, because of the company's business line. "Cisco would love to have everybody do a virtual close, because they would buy more Cisco equipment," remarks analyst Pyykkonen. But it will be a while before anyone else catches up to Cisco's current real-time finance capability.

"It is not just a matter of putting in a lot of computing power," the analyst says. "You need a lot of operational know-how to work with the information."

By Tim Reason. He is a staff writer at CFO, CFO Asia's sister publication in the US.

THE WINNERS CIRCLE
By reconfiguring both metrics and planning, Alcoa's finance chief wins twice.

RICHARD KELSON
Category: Planning Process Resource Allocation and Performance Measurement
By Alix Nyberg

In the fall of 1997, storm clouds suddenly darkened the horizon for Alcoa, the 112-year-old Pennsylvania-based multinational. Aluminum prices, a leading indicator of Alcoa's earnings, plunged 12 percent during one 60-day period. The Asian crisis weakened demand, and Alcoa's stock began to lag the industrial averages that it had beaten the previous two years.

CFO Richard Kelson was fresh on the job, having moved over from general counsel the previous May. With the company's 20 business-unit presidents anxiously awaiting next year's budget for their production and productivity goals, what was a new CFO to do? Kelson's answer: plenty.

The then-23-year Alcoa veteran not only knew the company well, but he also understood the macroeconomic conditions surrounding its 180 operations in 28 countries. And he was extremely familiar with the finance side through Alcoa's acquisitions. So, when Kelson suggested scrapping the existing 1998 operating plan and starting over with new metrics, then-CEO Paul O'Neill and then-COO Alain Belda listened. The two, now Alcoa's chairman and CEO, respectively, ultimately agreed, putting into motion a dramatic redirection that would make Kelson the only double winner in this year's CFO Excellence Awards - in the categories of Planning Process/Resource Allocation, and Performance Measurement.

The drive to rebuild both Alcoa's planning and its metrics has developed into the centerpiece of a financial transformation for the company. Gone are the one-year plans, replaced by three-year stretch goals. And six-quarter rolling forecasts now focus on changing expectations.

"The forecasts I was getting weren't worth the paper they were printed on, and I didn't care to see them," says O'Neill of the old Alcoa planning system. "After Rick overhauled the process, I was asking, 'When will I see the forecast?'"

The metrics overhaul was equally enlightening. Previously, for example, the company used yardsticks considered too myopic by Kelson. While Alcoa knew how many cans per hour or car doors per machine per year could be produced, such data limited comparisons. Now Alcoa blends three main approaches to metrics - cashflow return on investment (CFROI), a tailored form of economic value-added (EVA), and a balanced scorecard - strongly boosting the performance-based element at the company. And measuring more in financial terms let Alcoa stack its results against companies across all industries. "We said, 'It's not enough to be the best of the metals anymore,'" explains Kelson. "We tried to look outside of ourselves and ask, 'What do people expect of high-performance companies?"

Lofty Goals

Those expectations were determined initially by benchmarking the top market-performing companies in the area of return on capital - using a Stern Stewart EVA model. Kelson then applied Holt Value Associates LP's CFROI software to get the additional buy-side perspective of portfolio managers looking at Alcoa.

Using both measures, says Jim Knight, who leads Chicago-based SCA Consulting's performance measurement practice, helps the company communicate to diverse audiences. Both address use of capital, but while EVA is easier to explain to nonfinance employees, CFROI numbers give investors more confidence in the company.

"In order to be truly successful," says Knight, "you have to drive beyond stock-price and cost-cutting targets and identify the value drivers and figure out how to get there." To wit, some 60 percent of Alcoa's balanced-scorecard measures are financial, including capital intensity and overhead costs. The rest concentrate on such issues as minimizing lost-workday injury rates among factory workers. (Such injuries, incidentally, were halved between 1997 and 1999.)

To drive longer term performance, Kelson created three-year horizons for all the redesigned Alcoa metrics. Then managerial compensation was tied in. Many goals that Alcoa set were lofty - a US$1.1 billion cost-cutting, for example, and a stock-price boost to put Alcoa in the upper quintile of companies on the Dow Jones Industrial Average by end-2000.

Writing the "Philosophy Book"

Since most measurements were now financial, tracking progress toward goals became easier. To make progress obvious - or to highlight shortfalls - Kelson introduced unit-specific data books with graphs and charts comparing monthly results with historical trends, and tracking results alongside future goals. "The data books eliminate any temptation for 'sound-bite' management. You're now looking at things very much in context," he says. Introducing quarterly revisions to the forecasting process has added even more integrity.

While Alcoa's business units have some autonomy, each must earn a minimum 12 percent return on capital before any significant capital is invested in its growth. And compensation is based on both the return and the growth. As a general guide to allocation decisions, Kelson devised a "philosophy book" that outlines positions on everything from off-balance-sheet financing to funding small joint ventures.

Alcoa vice-president William Christopher, who heads the forged-products unit, says the business-review process makes "what-if" scenarios easier. "Now the challenge is analyzing the numbers, rather than generating them," he says. In one recent case, he planned for a slowdown seen far ahead in the heavy-trucking industry. "In the six-quarter rolling forecast, it became very obvious that the downturn was coming. In prior years, we would have been up to our eyeballs in meetings for two weeks about what to do right now."

In the last quarter of the original three-year plan, Alcoa is now hitting most targets. The company as a whole, currently at a 13.9 percent ROI, is aiming for 15 percent in 2001. Alcoa's stock was the top performer on the DJIA in 1999, gaining nearly 126 percent - and creating a tidy sum for Kelson, whose US$5.8 million in options-based compensation last year was sharply above his 1998 options income. While the stock's performance has been distinctly rockier over the first half of 2000, it was again climbing above the DJIA at the end of August, trading in the mid-30s.

Making Acquisitions Easier

Standardized measures also allow the company, now with 25 business units in 36 countries, to close its books in less than five days. "There are very few companies in the world that operate on a global level that can do that," says analyst Thomas Van Leeuwen of Credit Suisse First Boston.

Kelson is especially proud of the fact that internal processes have increased profitability enough so that Alcoa can both insulate itself against the cyclical industry's downturns and gobble up competitors. Alcoa has been particularly active in the latter area, acquiring major US rival Reynolds Metals for US$4.5 billion last May, and buying Alumax two years earlier. Yet, despite all its acquisitions, Alcoa managers "haven't seemed to increase spending. They've been very careful about how they've allocated capital," says Wayne Atwell, a managing director of Morgan Stanley Dean Witter.

Rising aluminum prices have helped, but Alcoa's cost reductions and merger-related operating efficiencies have also contributed to the 59 percent rise in net income for the first half of the year, despite charges stemming in part from the Reynolds Metals acquisition. Kelson's business-review process will be rolled out "immediately" at Reynolds, says CEO Belda.

Kelson and Belda recently sent a draft version of their 2003 goals to business-unit leaders, and are waiting for their comments. For now, they will say only that the goals will be designed to make Alcoa "the best company in the world," and eventually double its current revenue base of around US$20 billion. "Not so long ago, such a vision would have been ridiculous," says Belda. "Not anymore."

By Alix Nyberg. He is a staff writer at CFO, CFO Asia's sister publication in the US.

[This is the first of a two-part series. The second part will appear in our December edition.]