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The Digital Evolution of Back Office Finance
The challenges facing CFOs and back office finance teams have remained the same for decades – they seek automated solutions to simplify, enhance and streamline their activities, and ERPs simply don’t suffice. If you talk with the CFO or accountant of any small or mid-sized company, they will likely share the various work-arounds they have employed and the pain points they experience with manual data entry and systems that do not integrate. For potentially the first time, we believe that there may be brighter days ahead - with the proliferation of cloud computing, companies’ familiarity with Business Intelligence (BI), predictive analytics, data visualization and AI technologies, to name a few, small and mid-sized companies are more willing than ever to leverage more cost effective, configurable and innovative solutions to enhance the mainstream ERP functionality.
Shifting Role of the Modern CFO:
While the change and upgrades in technology are interesting, the real story is in the shifting role of the CFO, as their toolkits expand. In a recent study, The CFO Reimagined, Accenture explains that "In virtually every company we look at, the CFO is becoming the second most important C-suite executive. An effective leadership team depends on the CEO and CFO being a great double act.“ The role is transforming from traditional Operating CFO role, into the role of a Business Partner and Strategic Enabler, enhancing forward looking forecasting and decision making for organizations.
Figure 1: The Transformation of CFO
With the fast-paced evolution of markets, the challenge facing today’s CFOs is how they can free themselves from the traditional and tactical tasks to focus on strategic and longer term initiatives without compromising accuracy and efficiency.
What Does the Market Say?
ERPs have served as the backbone for financial management of organizations for decades, and a primary reason is due to the large financial investment and heavy lifting required to stand them up. Once these systems are implemented, companies are unlikely to turn to an alternative. However, in a recent survey of hundreds of finance professionals conducted by Auditoria.AI - a provider of AI-driven automation solutions for finance teams - the majority of participants complained that even the modern ERPs are not meeting their needs. In addition, if you look at Gartner’s Magic Quadrant for Cloud ERP for Product-Centric Enterprises, it is clear that very few legacy incumbents have transitioned to new age capabilities. Plotting ERPs against their Completeness of Vision and Ability to Execute, none of the big-name players shake out as true leaders in this space. So why does this matter to venture investors? Our hypothesis is that innovative startups have a fantastic opportunity to enhance (not replace) the existing ERPs, elevating their functionalities and enabling these players to become leaders in this space, and this growth is already underway…
Figure 2: Gartner Magic Quadrant for Cloud ERP for Product-Centric Enterprises
Based on pain points identified through discussions with 10 CFOs of SMBs and mid-sized companies, and an analysis of the opportunities arising among innovative startups in this space, there are three key macro-trends guiding these shifts:
1. Cloud - With firms transitioning to cloud solutions, we believe that back office will leverage these technologies more and more to drive automation and analytics, and will turn to startups to do so. Thinking back to the early 2000s, both SAP and Oracle saw extraordinary revenues with customers spending thousands on ERP implementations. These customers are not regretting these investments, but rather are seeking enhancements. Today, SAP and Oracle recognize trends toward cloud solutions and have demonstrated significant growth in this space, however companies are unlikely to conduct a second large-scale implementation, and instead we expect them to overlay cloud-based solutions on top of their existing ERP suite (See figure 3). It is important to recognize that although cloud revenue is expected to grow by 17% in 2020, the finance sector remains very early in cloud adoption. Tableau, for example, just transitioned to cloud in the past year, and it is evident that there remains a great deal of greenfield opportunity for the back office to follow. Based on a study of UK based companies, 46% of companies are not currently using cloud-based ERP solutions, while 61% of companies aspire to.
Figure 3: SAP and Oracle Annualized Cloud Growth Rate 2017-2019
2. Efficiency & Workflow Automation – With the new work from home environment as a result of the COVID-19 crisis, the need for automation has come to the forefront for back office finance professionals, as it has exacerbated deficiencies in non automated or non cloud-based systems. This is particularly important when we think back to the shifting role of the CFO, because there is a direct and positive correlation between automation and highly transactional activities in back office finance. Today, only 34% of finance tasks are automated, though McKinsey estimates that 60-80% of backward-looking accounting activity can be automated with limited to no human intervention. This trend indicates that as the “Operating CFO” activities are automated, CFOs will free up time and resources to dedicate toward forward looking reporting, analysis, advisory and planning to continue to support strategic efforts in their organizations.
3. Decision Making Analytics - As more and more companies are becoming data-driven, Financial BI is becoming central to the C-level decision-making process. While in the early 2000s, the solutions were much more siloed, today we see a broader scope and more providers competing in this space. Whereas corporate finance was once a reactive field often focused on past data, CFOs are increasingly using BI tools to become proactive strategists.
As these three macro-trends have developed, innovators have been building startups to address the key changes. In line with the new role of the modern CFO mentioned above, this market map depicts a view of key areas of innovation across back office finance.
Figure 4: Back Office Finance Market Map
Impact of COVID-19:
We would be remiss to craft any investment thesis in 2020 without taking into consideration the severe impacts of COVID-19 on our economy, and its natural implications on the back-office finance space. The current environment has accelerated Digital Transformation efforts of many enterprises and we expect that the Finance function will be a natural beneficiary of that overhaul.
Through conversations with concerned CFOs, overworked accountants and innovators trying to solve some of the toughest problems, what we found was quite simple: in a less stable economy, forecasting and modeling tools will be in higher demand as companies seek to better understand and predict revenue streams and costs in order to make informed financial decisions and adjustments more quickly. This indicates that not only will forecasting tools be critical for small and mid-sized businesses, but directed insightful budgeting tools will help companies to stay afloat. Due to the new work from home environment, self-serve cloud platforms will be in greater demand in these back-office functions.
Additionally, there will be an increased focus on sensitive financial data security and leveraging automation technology to institute proper controls/ governance and reduce fraud.
Lastly, looking back on prior economic downturns in history, companies sought automation opportunities to enhance efficiencies in their businesses. As we saw in 2010 with workforce productivity increasing at unchartered rates, we expect companies to seek business forecasting tools that will help to manage and plan for these changes, which reinforce the acceleration and changes of the workflow.
Key Takeaways / Focus areas for Us
1. Key capabilities that CFOs aim to optimize to drive strategic enablement: Cloud, Efficiency and Workflow Automation and Decision Making Analytics.
2. Mid-Market is the most interesting segment since the companies at this stage generally outgrow Quickbooks / Xero, have just the right balance of complexity and simplicity to be a good targets for self-serve cloud products, are a perfect onramp for land and expand, have low churn risk, higher ticket size than SMB, and general growth of this market, while less crowded than Enterprise ERP. Big companies are anchored by their historic ERP implementations, and these changes often only occur once per decade. However medium sized companies have a greater opportunity because they are nimble, growing, have easier ERP implementations and they are more likely to adopt cloud.
3. Although there are many companies working to automate basic back office functionality, this wave has passed, with majority of companies in this space in later/more mature stages. On the contrary, automated tools for forecasting and forward-looking analytics are in greater abundance among early stage companies, with opportunity for more meaningful investments in this stage.
4. Ultimately, we find the most compelling segments of this market to be companies that use cloud, automation, and analytics to provide forward looking and forecasting tools to enhance ERP functionalities. More specifically, Liquidity & Revenue Forecasting planning tools that enable CFOs to predict and forecast business opportunities and Financial Reporting & Management analysis tools that enable CFOs to better understand business needs.