Take costs out and keep them out
25 January 2017
With increasing uncertainty and disruption, many management teams are undertaking cost reduction programmes to create efficiency and protect margins.
Cost reduction has been high on management team agendas for several years. More and more we’re hearing a similar theme across all industries. That benefits from cost reduction programmes have not been sustained, and that within 18 – 24 months, those costs which took such effort to remove have crept back in, seemingly without any clear or valid reason. This yoyo effect destroys shareholder value and thus successful cost reduction programmes are those which make the cost cuts stick.
Having designed and implemented cost reduction programmes across different industries, our teams have identified five critical success factors:
1. Identify the right costs to remove
Many organisations set broad targets across all departments uniformly, eg every department must find 20% saving. This takes no account of whether departments or businesses are run efficiently, which entities actually require investment, and which ones need to be restructured. The thing is, when you remove costs from the wrong area you destroy shareholder value. Either, the costs come back and the initial capital investment was wasted (redundancy costs, management time etc), and / or you cause a negative impact to operations, which ultimately impacts customer service.
To achieve speed, whilst finding sustainable savings, we recommend accelerated hypothesis and validation to find “no regret” quick wins with short payback periods. Then undertake a deep analysis of cost drivers and spending categories to truly understand all costs, their return on investment and their relationship with demand (variable / semi variable / fixed). Understand scale by product or business unit and compare against current forecasts and pricing policies. An analysis of cost drivers and spend will often identify inefficiencies, where there is duplication of efforts, too many errors in processes, unnecessary numbers of management reviews layers in the back office and non-value added spend.
2. Give business unit owners accountability for implementation
It is important that the ultimate owner buys into the need to reduce costs and work with a leaner operation. A good way to achieve this is to make the business owner the sponsor for taking cost out in the first place. This improves the chances of cost being taken out properly and the likelihood that initiatives will be sustained.
3. Design appropriate controls and have the CEO communicate them
In a recovery period, after a cycle of low demand, it might be assumed that only variable costs will rise, and that they will rise in proportion with sales. This is often not the case, with austerity seemingly gone, bad habits start to return and many costs start to creep back. A number of examples include:
- travel and expenses policies being ignored;
- “pet projects” start up again;
- managers with a direct line to the CEO grow functions without following policy; and
- lack of diligence performed on investment cases destroying ROIC.
Controls and policies should be designed to:
- prevent operations being amended without a proper impact assessment and investment case; and
- maintain compliance in spending and recruitment policies.
Ideally the CEO would communicate any new controls and strongly remind people of the importance of complying with current ones. Setting this tone sends a clear message of the importance of staying tight on costs.
4. Create a performance management framework that rewards cost management
If development of controls provides the stick, then having cost targets aligned to performance metrics provides the carrot. Companies should keep cost management on the management teams’ scorecards during good times as well as bad.
Performance against these targets must then be measured; what gets measured, gets done. As part of the cost reduction exercise organisations should develop insightful KPI’s that can be easily mined from data sources. We’ve seen many a KPI pack make a thud on a boardroom table, but 90% of the KPI’s simply aren’t used.
5. See budget setting as an investment case
We still see many cases where budget setting is viewed as a finance exercise and often a last year plus inflation approach is taken as the starting point. To sustain cost savings, each budget setting exercise should be viewed as an investment of shareholders capital, so every pound spent should have a well understood rationale, and be aligned to the strategy of the business. Cost drivers should be utilised to develop and explain budgets.
We are often asked how to change business culture and attitude to cost; many organisations see this as the key to managing cost sustainably. In reality, a cost conscious culture is the output from doing the right things consistently, and applying a mixture of practical steps, which are readily measureable, with clear actions that create paradigm shifts in attitudes to cost.
In conclusion, we recommend that any cost reduction programme is developed, and implemented, with the end in mind. From the outset, successful management teams will ensure:
- cost reduction plans are developed based on solid analysis of cost drivers, but with accelerated validation and implementation of quick wins to achieve speed and momentum;
- the business leaders are bought into and accountable for implementation;
- appropriate controls are developed to avoid operations becoming lose or being destroyed;
- performance is properly and regularly monitored, insight is gained and feedback is provided to maintain low cost and continuous improvement; and
- budgets to deliver operations are developed based on a detailed understanding of cost drivers and aligned to strategy.
I’ve just outlined a few key themes our teams have identified when working with companies on their cost reduction programmes. Let me know your thoughts by sharing below or get in touch to discuss in person.