If AI holds the answers, are CEOs asking the right strategic questions?

The headline-grabbing explosion of generative AI in late 2022 and early 2023 has captured the imagination of business leaders, investors and consumers alike. Tens of billions of dollars have been invested into generative AI applications, with drug development and software coding being the most-funded use cases.

CEOs clearly see the huge upside opportunities of AI. They recognize its potential to drive productivity and positive outcomes for all stakeholders. Two-thirds (65%) agree or somewhat agree that AI is a force for good – driving business efficiency and therefore creating positive outcomes for society, such as innovations in health care treatments.

A similar cohort believes the impact of AI replacing humans in the workforce will be counter-balanced by the new roles and career opportunities that the technology creates – they reject fears that AI could negatively impact workforce numbers.

But CEOs are simultaneously concerned about any unintended consequences of AI – reflecting a broader confluence of views in media, society and contemporary culture where the exciting potential of artificial intelligence is often contrasted with the tropes of dystopian science fiction.

Almost two-thirds (65%) of CEOs say more work is needed to address the social, ethical and criminal risks inherent in the new AI-fueled future – from cyberattacks to disinformation and deepfakes. A similar number also worry that not enough is being done to manage the significant implications and unintended consequences for both the business community and society more broadly.

Government policymakers and regulators have a significant role to play in establishing rules and guardrails for how generative AI is used. And CEOs also see a role for the business community to engage much more on the ethical implications of AI and the impact of its use on key areas of our lives, such as privacy. They also highlight AI’s potential to disrupt the entire digital environment that exists today, especially with regard to privacy and online security.

Despite these concerns, CEOs are devising investment strategies to maximize the current and future benefits that AI can bring to their businesses. Capital allocation is being focused on these new technologies. With nearly a half of CEOs already fully integrating AI-driven product or service changes into their capital allocation process and actively investing in AI-driven innovation.

Many businesses see the potential of AI to accelerate their progress on sustainability at a time when investors, regulators and stakeholders across society are increasingly demanding greater environmental, social and governance (ESG) transparency. However, CEO respondents are split three ways in terms of how much capital to allocate to sustainability priorities.

Just over a third (38%) prioritize sustainability issues when making capital allocation decisions, with a similar number (34%) not making such issues a priority. The remaining respondents (28%) apply an equal weight as other business priorities.

Investor appetite has shifted toward sustainability-friendly businesses, while CEO prioritization seems to have moved in the opposite direction – short-term financial performance. The harsh realities of today’s low-growth, high-inflation and interest rate environment have no doubt encouraged many CEOs to focus more sharply on quarterly performance. On the other hand, for many companies, sustainability may already be baked into their strategic direction.

Nevertheless, to meet stakeholder demands, CEOs have to seek more effective ways of communicating strategic performance with both nonfinancial and financial metrics to help bridge the gap with investor expectations and align with more demanding stakeholders.

Accepting new realities, short-term volatility and risks

Given the near- to mid-term economic headwinds, the increasing cost of doing business, rising capital costs and elevated geopolitical tensions, it may come as a surprise that CEOs feel slightly more positive, with a net number of respondents agreeing that their performance over the next 12 months is looking brighter than at the start of the year.

However, CEOs are also having to manage a series of interconnected external risks to what would have previously been considered business as usual, with the majority anticipating a very significant or significant impact on their business over the next 12 months.

The past three years have been notable for the nature and pace of the multiple crises confronting companies. CEOs’ and business leaders’ significant focus on processing the principles of this fast-paced, stacked disruption has led to two major consequences:

• Companies get trapped in a reactive spiral, adapting to fast and fundamentally fluid situations at an increasing pace. This forces them to become more and more tactical and creates a barrier to thinking strategically for the long term.
• Time and focus are increasingly wasted on trying to picture the exact shape and form of possible futures rather than dealing with the necessary, no-regret moves they can make now.

Actions to take now

Adopting advanced monitoring and scenario planning to play out their actions and reactions to any further acceleration of external headwinds is key for CEOs. Companies should be regularly assessing their portfolio of assets, operations, ecosystems and supply chains, including routes to customers, and considering how each aspect of their business is impacted at a fundamental level. Fine-tuning each area to strategically manage the complex risk environment will bring benefits across the whole organization.

Focusing on the fundamentals and controlling what is in business leaders’ power to control will be CEOs’ most effective strategic and operational actions in the current environment. This can also be seen in capital allocation strategies.

In many ways, these areas of focus mirror the major challenges that CEOs now face. Be it a shifting geopolitical landscape, accelerating technology innovation and disruption or the need to become a more sustainable business, CEOs are looking to be on the front foot.

Making smart capital allocation decisions that drive long-term growth as well as increase short-term shareholder returns and stakeholder confidence is essential for the C-suite. To improve their company’s competitive position, leading CEOs are removing barriers to agile investing.

A data-driven, consistent and enterprise-wide approach to capital allocation that focuses on qualitative and quantitative metrics can help CEOs make objective investment decisions, navigate disruption and drive long-term value creation.

Sustained transformation to fuel future prosperity

This proactiveness in capital is reflected in CEOs’ plans for transformation.

The majority (63%) of respondents are either maintaining or accelerating their portfolio transformation. Of this bolder cohort, the main source of financing their transformation will come from performance improvement. This reflects how the environment has shifted over the past 18 months from one of growth at any cost, fueled by ultra-cheap money and elevated liquidity, to a new paradigm where investments have to be sustainable, with a clear path to profitability or value creation.

The context for financing has changed fundamentally. Policy interventions to mitigate crisis symptoms have been a source for attractive temporary financing and subsidies, and the market is still partially flooded with these funds. However, more recent monetary policy moves to contain the unintended consequences of too much liquidity — sharply raising interest rates in a fight against high inflation — have created an environment where a resulting credit squeeze is possible.

As a result, companies are refocusing on short- to medium-term liquidity and furthering their efforts to control costs and financial risks. This threat emphasizes the need for liquidity focus and the immediate issues they are facing may center on:

• Understanding exposure
  • Understanding short- and medium-term capital and liquidity needs (coordination with treasury forecasts)
  • Assessing access to cash in the short term (balances, borrowing facilities, capital calls) and coordinating backup funding sources, as needed
  • Assessing exposure to financial institution partners (balances, terms of cash management accounts, cash products)
• Exploiting internal financing potential to the maximum and increasing resilience while freeing up capital for investment in transformation
  • Optimizing working capital management
  • Reducing direct and indirect costs through an attitude of constant challenge
  • Striving for agile cost structures and light asset footprints

It is difficult to predict exactly how all of this will play out. But one thing is becoming more certain – the availability of external financing will continue to tighten and become more expensive. And that will mean that the cheapest, most accessible and reliable source of funding their company’s transformation may be in the CEO’s own internal cost control.

CEOs are clearly signaling that they want to increase the pace of M&A over the next 12 months.

A near-record-high of almost two-thirds of CEOs (59%) plan an acquisition in the next 12 months, up from 46% at the start of the year. Almost half (47%) plan to divest assets. This strong sentiment indicates an acceleration of dealmaking through the rest of 2023 and into 2024 – but current barriers to doing deals, such as increasingly restrictive regulation and a higher cost of capital, will likely mean many of those plans stall.

While the deal market started 2023 very softly, there has been a pickup of deals through the second quarter. CEOs are accepting the new realities of deal fundamentals, including bridging a wider valuation gap, more expensive funding and a greater likelihood of regulatory scrutiny. However, all of these factors still have the potential to stop deals from getting over the line.

Despite an increasingly complex M&A environment making transactions more difficult, the fundamental deal drivers that accelerated the M&A market through the second half of 2020 to the end of the first half of 2022 remain intact. The need to respond to technology-driven disruption is not going away anytime soon.

With AI and new technologies emerging and maturing ever more quickly, companies that can leverage them as instruments of creativity will perform better. Companies will need to deploy technology faster to cater to the evolving needs of customers, employees and the business ecosystem. This is likely to accelerate investment in digital assets – such as AI capabilities – leading to more transactions, with companies looking to improve their value proposition and/or reinforce their market position.

CEOs are also leveraging these technologies to strengthen their M&A processes themselves. When asked if they are making use of AI as part of their approach to transactions, only a tiny cohort (5%) is not currently using these capabilities or has no plans to – and they risk being outmaneuvered by the competition.