1. Researchers analyzed European companies that proactively reduced costs before the 2008 financial crisis to determine what factors allowed them to perform better long-term. 2. They found that proactive companies scored higher on three "visionary variables": degree of innovation, degree of centralization, and internally sourced CEOs. 3. Specifically, proactive companies invested more in research and development, had more centralized business functions, and were more likely to promote CEOs from within instead of hiring externally.

1. What factors determine long-term
solid financial performance?
54 Volume 5 │ Issue 1
Article

2. Authors
Sebastiaan Nijhuis Director, Advisory Services
Ernst & Young, the Netherlands
Jelmer Westerhuis Advisor, Advisory Services,
Ernst & Young, the Netherlands
In a climate of ongoing economic uncertainty, when the threat of severe economic shock looms large,
some companies are managing to thrive. By adhering to a set of management principles,
they are building strength in the face of adversity. So what is it that these companies are actually
doing? We analyzed a specific group of European companies to find out.
55

3. T
he financial crisis of 2008 was the worst the
world has seen since the 1930s. The last four
years have seen economic retrenchment in
Europe and stability has not yet returned to the
market. Although the prospect of a Eurozone
breakup appears to be receding, corporate
leaders are once again being forced to revaluate
their businesses as they contemplate a decade of
low-growth levels in Europe.
Some companies have proved better equipped than others
in managing this ongoing turbulence. What steps have these
companies taken that enable them to become stronger in
unpromising conditions?
Many theories have been developed to explain the outstanding
performance of companies and right after a crisis is a good moment
to test whether the theories hold firm.
Centralization is often
the answer to improved
operational efficiency
and plays a key role in
controlling costs.
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4. Proactive versus distressed
To identify the factors that underpin strength, we selected a number
of European companies that responded quickly to the changing
market conditions in the run-up to the financial crisis of 2008. They
did so by implementing significant cost reductions in preparation
for the downturn to come. In the two years following the cost
reductions, they achieved a significantly better performance
compared with the companies that had not made such preparations.
Proactive companies responded before their performance
declined — unlike the distressed companies, which did not take
action to address their underperformance.
Making a distinction between “proactive” and “distressed”
firms is probably the most crucial identifier in our research. This
distinction is supported by Jim Collins (2001) in his book Good
to great: why some companies make the leap ... and others don’t.
He identified that a common trait among “great” firms was that
they all reacted quickly to change by facing up to the facts and
taking action accordingly. Tom Peters (1984) described similar
traits in his book In search of excellence. He found eight themes
that were common to “excellent” firms, one of which was that they
had a “bias for action.” In other words, if the environment changes,
and if the market conditions worsen, excellent firms take action
and adapt.
We studied a group of firms that reacted quickly to changing
market conditions by implementing major cost reductions. These
firms did so either for proactive reasons or for distressed reasons.
We investigated whether these two groups of firms had different
scores on carefully selected success factors.
Success factors
Management literature suggests a series of factors that underpin
superior performance. These include levels of debt, boardroom
gender balance, ownership structure, the strength of a binding
mission statement and common culture and levels of corporate
social responsibility. However, our study focused on three important
factors that could be tracked and measured. These factors,
or “visionary variables” as we call them in the study, are partly
informed by the book Built to Last,1
in which the authors highlight
“visionary habits” as the defining factors for successful companies.
Our key visionary variables are: the degree of innovation, the
degree of centralization and the degree of internally sourced CEOs
(see Figure 1).
We anticipated a stronger relationship between the three
visionary variables and proactive companies than with distressed
companies. If proved true, this would help to explain why proactive
companies continue to grow stronger and record a more stable
financial performance.
Figure 1. The three visionary variables
1 2 3Degree of
innovation
Degree of
centralization
Internally
sourced CEO
A high degree of innovation is an indication
that a company focuses on long-term
profitability. Consistent investments in
innovation will enable a company to keep
renewing itself, so it can adapt to the market
and stay ahead of the competition. It ensures
long-term stability and allows a company
to be creative and respond to changing
market demands with innovative products.
A high degree of centralization indicates
that the company can look at the impact of
decision-making on the whole organization.
Centralization is often the answer to
improved operational efficiency and plays
a key role in controlling costs.
Internally sourced CEOs are those who are
trained and educated within the company,
instead of being recruited from outside.
This is important because an internally
sourced CEO is often better equipped
to understand and build on the company’s
core identity, values and purpose.
Having an internally sourced CEO is likely
to strengthen unity within the company,
leading to increased retention rates among
the brightest and best staff.
57
What factors determine long-term solid financial performance?
Having an internally sourced CEO
is likely to strengthen unity within
the company, leading to increased
retention rates among the brightest
and best staff.
1. J. Collins and J. Porras, Built to Last, New York: HarperCollinsPublishers, 1994.

5. Research methods
Researchers took quantitative data from the companies’ financial
statements. To measure innovation, we followed a formula
established by Collins. We divided research and development by
sales and measured a five-year average. If companies invest more
in research and development, the percentage by sales will become
bigger. The second measure was fixed assets divided by sales,
which was also measured over a four-year average. If the company
invests significantly in plant, building and equipment, it is able to
deliver on innovative ideas. A third measure is the dividend payout
ratio, measured as a five-year average. If the dividend payout ratio
is low, the company sees innovative opportunities within its own
company and will reinvest its money back into the company, instead
of paying it out as a dividend. In other words, a low dividend payout
ratio will be a sign of high innovation within the company.
All companies are compared with their direct competitors on
these three variables for multiple years. We measured how well
they did and marked them accordingly. A low mark of one indicates
that the firm performed worse than its direct peer, a mark of
two indicates similar values on the three variables and a mark of
three indicates that the firm scores higher on these variables and
therefore has a higher degree of innovation.
To measure centralization, we identified seven business
functions within the company — including accounting, legal and
human resources — and scoured annual reports to find out if each
was centralized. If one or two functions were centralized, the
company was awarded a low mark of one; centralization of between
three and five functions earned a moderate mark of two and a high
mark of three was awarded to those who had centralized more than
five functions.
For an internally sourced CEO, we assessed the background of
the CEO at the point in time at which the company implemented
cost reductions. If, at this point, the CEO had been in the company
for more than three years before becoming a CEO, they would be
considered as internally sourced, and were given one mark. Other
CEOs were considered external and were not awarded marks.
Proactive companies have more visionary variables in place
Our investigation indicates that proactive companies have visionary
variables in place to a higher extent than distressed companies.
In other words, companies that respond to changing market
conditions proactively boast a higher degree of innovation, operate
their businesses in a more centralized fashion and employ more
internally sourced CEOs. The variable that sees the most significant
difference between proactive and distressed firms is innovation.
Continental European companies
versus UK companies
The research was based on a sample of firms that implemented cost
reductions. Of these companies, two-thirds were based in Germany,
the Netherlands or France, and one-third was based in the UK.
In our sample, more UK-based companies proactively reduced
costs than their European counterparts (75% of UK companies
versus 52% in Europe). In other words, more UK companies
responded swiftly to changing market conditions before their
financial performance declined. Indeed, in our sample, only 25% of
UK companies implemented cost reductions for reasons of distress,
compared with 44% of European firms.
We identified some noteworthy differences between proactive
UK firms and the proactive firms from the other European
countries. Overall, European companies score higher on the
combination of visionary variables.2
While the UK companies tend
to be more innovative, their continental counterparts run business
functions in a more centralized way and are more likely to source
their CEOs internally.
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A high degree of innovation
is vital to a company’s
long-term success.
2. Insignificant on a 10% significance level (.479>.1, independent sample t-test).

6. Figure 4. How proactive UK and European companies match up
0
10
0
10
(1=low, 2=moderate, 3=high)
0
10
Three years active in company
before becoming CEO
(0=no, 1=yes)
(1=low, 2=moderate, 3=high)
00
Proactive
European
firms
Proactive
UK firms
1 2 3Degree of
innovation
Degree of
centralization
Internally
sourced CEO
7.046.97
5.005.15
6.116.36
Figure 3. How the three variables combine across proactive and distressed companies
All variables Innovation
+ CEO
Centralization
+ CEO
Centralization
+ innovation
1+2+3 1+3 2+3 1+2
00 All proactive
firms
All distressed
firms
4.734.32
6.856.07
5.545.18
6.095.60
10 1010 10
0 0 0 0
Figure 2. Comparison of the three variables across proactive and distressed companies
6.966.19
0
10
5.225.00
0
10
(1=low, 2=moderate, 3=high)
6.525.71
0
10
Three years active in company
before becoming CEO
(0=no, 1=yes)
(1=low, 2=moderate, 3=high)
00 All proactive
firms
All distressed
firms
1 2 3Degree of
innovation
Degree of
centralization
Internally
sourced CEO
59
What factors determine long-term solid financial performance?

7. Figure 5. Recommended actions: how to boost your visionary variables
1 2 3Degree of
innovation
Degree of
centralization
Internally
sourced CEO
• Set up succession planning
• Create a talent pool
• Create strong common culture
to limit outflow of employees
• Compare innovation ratios
to industry average
• Adopt innovation in corporate goals
• Reserve resources for stimulating
innovation within the firm
• Evaluate all business functions to see
if they can be executed more efficiently
• Compare to best practice in industry
• Evaluate pros and cons of
centralization of business functions
Putting theory into practice
Our investigation showed that proactive companies achieved higher
scores on the three measured visionary variables than distressed
companies. These results indicate that proactive companies not
only report stable financial performance during and after a crisis,
but also boast a higher degree of innovation, centralization and
employ more internally sourced CEOs.
The degree of innovation is vital to a company’s long-term success.
A number of actions can be taken to boost innovation. It should be
incorporated into corporate mission statements in order to create an
innovative mindset throughout the company. Innovative ideas should
be rewarded. All employees should be encouraged to come up with
ideas on how to improve the company. In addition, resources should
be made available to allow employees to do so.
To increase the degree of centralization, all business functions
within the company should be assessed to ensure that they are
administered as cost-effectively as possible. Many business functions
can be managed centrally, saving costs as a result. Benchmarking is a
useful way to learn from best practices within the industry.
To increase the likelihood of the next CEO and future CEOs
being sourced internally, a talent pool needs to be established.
When talent within the company is tracked, a succession planning
schedule should be set up to provide the appropriate career and
training facilities. This enables the company to think ahead and
build stability in the long term.
Thriving in harsh conditions
Our investigation showed that proactive companies that quickly
respond to changing market conditions outperform their peers.
They score higher on the visionary variables of innovation,
centralization and internally sourced CEOs.
To strengthen their position, today and in the future, companies
should be aware of how these variables affect their long-term
stability. And, by adopting an innovative mindset, executing their
business operations as efficiently as possible and ensuring a strong
common corporate culture championed by an internally sourced
CEO, companies can help themselves to withstand and thrive in
today’s tough economic climate.
To strengthen their position,
today and in the future,
companies should be aware of
how these visionary variables
impact their long-term financial
performance stability.
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Article

8. 61
What factors determine long-term solid financial performance?
How Ernst & Young helped a European business
consisting of a manufacturing, retail and sales
division across 35 entities in more than 20 countries
to centralize operations and reduce costs.
The business as a whole was under extreme cost pressure.
It had to reduce costs and improve efficiency and effectiveness
across all its functions. All divisions were moving from
a country-based operation to a European-led operation,
leveraging economies of scale and leading practices,
and reducing overall sales and general administrative costs.
The company had employees based in all entities running
two ERPs with non-standard processes and significant
duplication of activity.
Value delivered
Ernst & Young worked with the client to:
1. Design a transformation program that included a new
operating structure, shared services, new technology and
a standard process model
2. Implement one standard design for the sales and
manufacturing operations and a separate design for retail
to optimize business operations
3. Deliver a full set of standardized processes and a phased
transition plan in readiness for implementation
4. Provide a future organizational design for both the new,
shared service center and for the retained organization