Academic researchers in the fields of finance and strategy have produced a large body of empirical evidence suggesting that corporate resource allocation is inefficient, with explanations ranging from misaligned incentives to internal politics to psychological factors such as confirmation bias. Regardless of the cause, inertia appears to reign at many organizations. In our experience, capital deployed at the business-unit level typically remains quite static, even as prospects for growth and capital returns change over time. Financial statement reviews also generally show an extremely high correlation from one year to the next of capital allocation between business units.
In our survey, we sought to go a level deeper by asking CEOs about the frequency with which they and their organizations employed seven resource reallocation mechanisms. Three of them (initiating investments in new projects, stopping low-potential or non-aligned projects, and doubling down on high-potential projects) were at the project level, and the remaining four (scaling up high-performing businesses, trimming low-performing businesses, divesting businesses, and acquiring businesses) represented business-level decisions.
In a separate part of the survey, we asked CEOs about their performance, defined as profit margins or return on assets (depending on the industry), over the previous 12 months. Then we undertook factor analysis, which involves grouping highly interrelated individual questions into variables that can be analyzed and correlated with performance outcomes.
Across the survey as a whole, both resource allocation (comprising all seven factors) and a second factor we created for the survey, related to customer trust, stood out as positive, statistically significant correlates with financial performance (For more on trust, see “Translating trust into business reality.”) Not surprisingly, headwinds in the survey, such as global threats, decarbonization pressures, and tax risks, were negatively correlated with profit margins.
We further dissected resource allocation by studying it on its own, against two control variables (industry and firm size) that typically dominate in industrial organization studies. Many variables simply don’t show up when set against industry and firm size, but resource allocation explained 28% of the model’s variance for profit margins, an unusually high explanatory level for a single factor.
At this point, it is worth mentioning that regressions of this sort measure correlation, not causation. In other words, high degrees of resource reallocation could cause strong performance, or strong performance could stimulate more frequent resource reallocation. That might be the case, for example, because a well-performing firm simply had more resources available to launch new initiatives. Because we asked about both starting and stopping projects and business-level initiatives, we are comfortable surmising that performance is unlikely to have prompted resource reallocation. It’s not uncommon for leaders to invest more when their success generates surplus resources, but it’s rare, in our experience, for extra resources to cause leaders to stop investing.
The fine-grained nature of our data enabled us to do something that has eluded academic researchers: assess the impact of project- versus business-level resource reallocation, as well as the impact of individual resource reallocation mechanisms. We learned that seemingly mundane activities like “seeding” (starting and boosting investments on projects) and “weeding” (killing projects) matter just as much as (actually a touch more than) their more prominent brethren (business-level moves, including mergers and divestitures). This is important and vital news for executives: small, everyday processes appear to matter just as much as the large ones that often command the most serious attention.
Decisions about projects have about the same impact as large-scale business decisions.
Project-level decisions(e.g., initiating or stopping projects)
Business-level decisions(e.g., acquisitions and divestitures)
To get even more fine-grained, we compared resource reallocation frequency with profit margins for all seven mechanisms. (More specifically, we looked at the differences in profit-margin levels for respondents who indicated that they had undertaken more frequent reallocation.) All of the differences are substantial and statistically significant, with five of the seven mechanisms showing significance at the level of rigor (p < 0.05) used in academic research.
Analysis reveals the profit-boosting power of making new moves.
In addition to confirming that project- and business-level resource moves impact performance similarly, two other points emerged from the data and merit emphasis. One is the apparent inseparability in resource reallocation of “starts” and “stops.” Two of the five mechanisms that pass the most rigorous tests for statistical significance reflected project- or business-level starts (invest in high-potential projects and acquire businesses), and the remaining three represented stops (stopping projects, trimming low-performing businesses, or divesting businesses). Second is the positive impact of frequent acquisitions. Many studies of M&A show that its impact is, at best, a wash for buyers, who sometimes overpay as a result of the “winner’s curse.” Our data shows something different: a significant performance edge associated with more frequent M&A. Our interpretation is that frequent, fairly programmatic M&A can be a performance enhancer. Such an interpretation can be entirely consistent with the fact that there is a high degree of performance variance around the “big bang” M&A activity that gathers headlines and dominates some studies, because of the large market capitalizations involved.
What accounts for these results? And what should you do about them? The first question isn’t answered by our analytics, but in our experience, effective project-level decision-making taps into some powerful forces. These include proximity between the initiative and the decision maker; the ability to match people with project needs in a fine-grained way; autonomy and empowerment; and morale (a force multiplier that can improve markedly with small-scale initiative-taking, or when energy-sapping dud projects are killed).
As for what to do about these findings, we’d be the first to acknowledge that it’s still early days for us in translating what we’ve learned into a resource reallocation strategy for executives. But a few things seem clear:
Project-level decisions are frequently being made in meetings that you may or may not attend or even have visibility into. Those decisions, collectively, may impact your performance as much as the big strategic bets you and your top team invest significant time in.
It’s critical, therefore, to take a hard look at the processes, policies, and operating norms you have around projects. A well-known example of a company encouraging project exploration was Google, which at one time allowed employees to allocate up to 20% of their time to the projects of their choosing. The result was successful new products such as AdSense, Gmail, and Google News.
Of course, if you’re going to encourage project-level entrepreneurship, you also need “stop” mechanisms to ensure it doesn’t get out of control. The baking company Goodman Fielder maintained at one point more than 550 R&D projects. The company appointed a “project killer” who pruned that down to 200.
We’d further suggest that executives should stay on the lookout for overly centralized processes that inhibit project-level initiative-taking. Red flags include approvals that bubble up to high levels of the organization for minor projects, and command-and-control funding for projects that are clearly the domain of individual business units. Such processes contrast starkly with the frequency and small-scale entrepreneurship that our data suggest are important.
In addition, organizational innovations such as enterprise agility—intended to decentralize, empower, and enable nimbleness—may be even more important than they appear, if they boost the effectiveness of project-level resource allocation.
Finally, don’t be afraid of acquisitions—especially smaller, lower-risk ones that can be undertaken more frequently and that likely contribute to the performance benefits we uncovered in this research.
Clearly, the application of principles like these will be heavily dependent on organizational context and business circumstances; we’re not suggesting they are iron-clad rules for running a company. Rather, we advise leaders to pay more attention to the processes and practices that guide the “under the radar” decision-making, because its impact appears to be significant.