Despite what the business-page headlines would have us believe, some of the most advanced risk management approaches still come out of the financial services industry. I caught up with Mike Pugliese, co-lead of Capco North America’s finance risk and compliance group, to learn about the wider application of risk-adjusted profitability.

Eric Krell: The sluggish economy and anemic recovery has put downward pressure on revenues across most industries. How can organizations strategically cut costs and protect and grow their revenue stream in this environment?

Mike Pugliese: For financial institutions, there is downward pressure on revenue for two reasons: the economy and the regulatory mandates coming out of Washington D.C. However, all businesses are coping with the difficult economic environment.

Regardless, it comes down to having the right information about your business and the performance of your business to make educated and sustainable cuts in operating expenses without damaging your overall strategy. It’s important to understand the profitability of the products and services you offer and the value these bring to the organization in order to maximize revenue streams or look for new opportunities to create revenue based upon that information.

Organizations need to preserve or protect the revenue they currently have, look for opportunities to increase revenue in the existing client base and create new revenue streams through new service offerings. Cost-cutting must occur simultaneously but it has to be strategic and thoughtful so it does not damage your brand or negatively impact current customers.

Eric Krell: What is risk-adjusted profitability?

Mike Pugliese: Risk-adjusted profitability allows for a prudent growth strategy rather than a “growth for the sake of growth” strategy. It’s a view of profitability that takes into account both an organization’s expected losses (e.g. credit losses) and unexpected losses (e.g. what organizations are holding capital against). It allows organizations to have a view of their revenue on a risk-adjusted basis so, for a particular revenue stream, they know how much expected and unexpected risk is being taking on and therefore how much capital is needed to hold against it. This allows companies to make better investment decisions with capital and target capital investment towards products and services that have the highest risk-adjusted return.

Eric Krell: Why is this so important in a still-uncertain post-crisis environment?

Mike Pugliese: In the post crisis environment, risk adjusted profitability can help organizations make better decisions around the allocation of scarce capital. It can also allow organizations to get out of businesses or stop offering products that cause companies to take on an unreasonable amount of risk. Fundamentally, it comes back to delineating between a “growth for the sake of growth” strategy vs. a prudent growth strategy.

Eric Krell: You have also mentioned customer centricity in the context of the finance function. How does this concept apply to corporate finance and why has the current economic environment made it important?

Mike Pugliese: In this economic climate, an organization’s main objective is to protect the revenue it has, maximize it, and attract more. Given this, it’s more important than ever to understand the profitability dynamics of their customers and how to create products and service offerings that best serve those customers.