Strong Governance  575 Granular Decisions Decisions also need to be made at the right level of granularity. Consider a large health-care company that was organized around three divisions, with each divi- sion having roughly 20 business units. The company had a culture of decentral- ized decision making, so executives allocated R&D and sales and marketing spending to the three divisions and let the division leaders decide how to allo- cate across their business units. The result: spending was aligned not with cor- porate priorities, but with the short-term incentives of the division heads. Even worse, if one business unit was having a difficult year, the division head would frequently ask other units to pull back funding from longer-term investments. The solution in such a case is for the CEO, often with the CFO, to allocate resources and set performance targets at a much finer-grained level. As we discussed in Chapter 29, for a company with around $10 billion in annual revenues, resource allocation works well at a level of 20 to 50 units or projects, though some companies go further. Allocating resources at a more granular level requires more CEO time. But we believe that careful allocation, as one of the CEO’s most important deci- sions, is well worth the extra time and effort. In our discussions with compa- nies, we’ve observed a dichotomy between companies where the CEO and CFO allocate at only a high level versus those that are much more detailed. More granular allocation is typically more effective at ensuring that spend- ing is aligned with long-term priorities. One large company spent more than $10 billion per year in capital expenditures, but the top corporate executives spent only several hours per year in their final deliberations on how to allocate that spending. After working through a new process, they increased their time spent on resource allocation to two days. The result: a finer-grained capital spending plan more tightly linked to the company’s overall strategic priorities. Strong Staff To make allocation decisions, CEOs and CFOs need effective staff support. This usually takes the form of a financial planning and analysis (FPA) team and/or a corporate-strategy team. Despite the importance of this role, many companies have in recent years cut the resources of their FPA teams to levels where they barely have time to coordinate the planning process and add up the numbers. This misguided gesture, aimed at setting an example of com- mitment to spending reductions, has left no capacity for thoughtful analysis or for challenges to business units’ resource requests. In these situations, any challenges to business unit plans are left to the CEO or CFO, who often lacks sufficient knowledge to build a strong case. In contrast, we’ve observed that companies with stronger FPA or corporate- strategy teams tend to draw valuable insight and influence from the teams. This appears to make a large difference in the effectiveness of their planning 576  Strategic Management: Mindsets and Behaviors and resource allocation. Common indicators of a strong FPA capability include an FPA leader with real stature and influence inside the company, team mem- bers with extensive experience in different parts of the company beyond fi- nance, and a team with time to do its own analysis of the current and potential performance and opportunities for different business units. Debiased Decision Making When it comes to making decisions, human beings have built-in biases. So do companies and other organizations. In any number of ways, these biases can stall, skew, or deny the kind of clear-sighted decisions that are at the heart of strategic management. To put in place the right sets of behaviors and pro- cesses to tie strategy to value creation, management must make tangible ef- forts to overcome these biases. This section defines some of the most common behavioral biases that we have seen affecting important strategic-planning sit- uations. By identifying and remedying the distorted thinking associated with these biases, executives can improve the quality of their company’s decision making. The good news is that, in many cases, simply having strictly enforced rules and processes for managers and employees can reduce the incidence of biased thinking. A culture that promotes strong analytics also can help (see Chapter 29). Inertia (Stability Bias) Inertia, or stability bias, is the natural tendency of organizations to resist change. A study by colleagues of ours found, on average, a greater than 90 percent correlation of spending allocations across business units from year to year.4 Furthermore, the correlation for fully one-third of the companies was 99 percent; that is, the allocation of spending to business units essen- tially never changed. The same study showed that companies that reallocated more resources—the top third of our sample over a 15-year period—earned, on average, 30 percent higher total shareholder returns (TSR) annually than companies in the bottom third of the sample. The solution to inertia bias is relatively straightforward. Rank initiatives across the entire enterprise, as described in Chapter 29. In addition, ensure that the budget you are building is rooted in the current strategic plan, not last year’s budget. The essential idea is to ignore as much as possible the influ- ences of past allocations or budgets. In practice, you may not be able to shift resources as quickly or as much as this approach suggests. But trying to ignore the past as a starting point will help you minimize the inertia. 4 S. Hall, D. Lovallo, and R. Musters, “How to Put Your Money Where Your Strategy Is,” McKinsey Quarterly (March 2012), www.mckinsey.com.