Cost Cutting: The Ten Percent Non-Solution

Nearly 800 years ago, an unknown Florentine banker invented double-entry bookkeeping. A fragment of his account book survives, proof that as far back as 1211, keeping track of outgoings and incomings was a challenge.

 
Even with all the data, spreadsheets, and IT systems at a modern CFO’s command, their picture of their business’s costs is unlikely to have the clarity and simplicity of a 13th-century banker’s, making it especially hard, at this critical point in corporate history, to be sure they are managing cost effectively. That’s why the institutionalized approach – ‘a 10% cut in budgets across the board’ – is so appealing. Appealing but potentially dangerous.
 
The key is not to cut costs, but to optimize them. The distinction might sound meaningless but Steve Hill, Global Head of KPMG’s Business Performance Services practice, disagrees. “It’s about getting people to do things better, smarter and more efficiently. You have to look at how to shift assets to value creation. That’s why KPMG firms talk about cost optimization, not reduction or cuts.” The aim is to cut the right costs through operational and organizational change that will ultimately make the business more viable in the long term.
 
Hill suggests one of the first steps is to look at your business in 3D. Focus on key factors as you consider the problems you face: people, processes, technology and risks. “You should look at these in terms of sustainability,” Hill says. “Then measure them to ensure those metrics have been maintained or improved on.”
 
1 Don’t be scared of the bigger picture
You don’t have to outsource key operations to India to benefit from the principles of frugal engineering. “It’s reverse engineering,” says Hill. “You figure out where you need to be and go back and see how to do it.” In other words, think like a start-up – work out at what price you need to sell your product or service and work backwards.
 
This could mean tearing up established processes and starting again. Every strategy starts to decay the day it is created and you may need to reinvent your business model to compete with newer rivals. “Ask yourself if it’s possible to simplify your business model and whether your model was correct in the first place,” says Hill.
 
2 Thinking small can be useful too
When Larry R. Carter became CFO of Cisco Systems in 1995, he was amazed by the size and complexity of the monthly profit statements. Reducing them to a single sheet of A4 was the most obvious way to prove financial processes were being rethought. He went on to amalgamate departments, giving managers the power to restructure them in the most efficient way possible. The sound base he put in place is one reason Cisco now has US$30 billion in cash.
 
3 Share the pain
It’s good for morale if staff can see that senior management are suffering too. FedEx CEO and founder Fred Smith has taken a 20% pay cut: “All our management compensation is heavily related to the performance of the company,” he says. “At the first-line management level it’s maybe 15% or 20%. At my level it’s 90%. So obviously, as the economy has gotten weaker, a lot of that expense has simply gone away.” Smith’s act of leadership sends out a strong message to staff and investors.
 
4 Look beyond your peer group
It’s easy to emulate your rivals’ cost-cutting strategies, but are they the most effective for your business? “CFOs should look outside their traditional peer group for ideas about cost,” says Aidan Brennan, Head of Performance Advisory for KPMG Europe LLP and  partner in the UK firm. “It's beyond traditional benchmarking, instead asking bigger, more challenging questions by looking for alternative comparisons.”
 
Instead of just aiming to reduce the cost of the finance function by 10%, CFOs could consider moving the function offshore or to shared services. As Brennan says: “You only get to the big prize if you do something big.” Simplifying the finance function by streamlining traditional processes may also free up the department to take a more strategic role.
 
Four years ago, Tony Davis, CEO of Singapore’s low-cost carrier Tiger Airways, decided the airline industry’s cost base was unsustainable. “We don’t look to Cathay or British Airways for inspiration but to Amazon,” he said. Getting the cost base right was essential if Tiger was to compete on ticket prices and stood it in good stead when fuel costs surged. Davis now expects to win new passengers in a recession and believes business passengers will account for 15% of its traffic by March 2010.
 
5 Engage the workforce
Plotting a clear course forward is vital. “If your whole message is ‘we have to do this cheaper’ you don’t energise an organization,” says Brennan. “It is really effective when the message comes from the top of the organization, painting an idea of a future strategy. Winning people’s confidence is an important part of change management and that comes from leadership. Difficult times put a premium on leadership and it is a unique opportunity to build and enhance trust and show everyone is working on things together.” If staff have a sense there is a long-term strategy, they are more likely to bear the short-term pain.
 
Working with the relevant parties can also help you focus your cost optimization efforts. Cutting capital expenditure can, superficially, seem like an easy save but a collaborative approach should, at least, ensure that the business isn’t harmed. The same approach could yield sustainable cost savings in inventory. Some consultants suggest that a sustained, careful systematic attempt to eliminate such buffers as “I order a week early just to be on the safe side” can reduce inventory by 20% without jeopardizing the future of the business. Swiss chemicals company Clariant has assigned a team of 40 people to work on reducing global inventory, with CEO Hariolf Kottmann lauding its effects after just a few months of scrutiny.
 
Recessions are a self-evident catalyst for change. And a business that develops line managers’ leadership skills – and asks them to lead on an issue as vital as cost optimization – will find itself better placed in the long run.
 
6 Manage your head count wisely
Many cost-cutting programmes rely on head count – it is a quick win if businesses just want to survive, and the savings are relatively easy to predict. But simply getting rid of staff is not always the best strategy, and can be poorly executed. “Focus on those who are performing better, and focus on ‘fit’ to get the skills to make the business better,” says Hill.
 
If job cuts are not properly coordinated and communicated, staff may be distracted by the need to mend processes and the workforce may be unfocused and unmotivated. A more strategic approach could be to consider a 5% reduction in salaries and a flexible work program.
 
7 Technology isn’t always the answer
Managers looking to improve efficiency often latch on to technological solutions – and staff, especially in technically driven organizations, will  often suggest these. But one global chemical company, running a pilot project to improve efficiency, found that 60% of the value it generated came from new work processes.  This realization led the group to raise its goals, sometimes by a factor of three. Italian distribution company Amplifon sees the downturn as a positive opportunity to focus on embedding existing systems, rather than expand. CFO Ugo Giorcelli says IT costs account for only 1% of sales – looking at the supply chain, and cutting down on outsourcing, will save more.
 
8 If you’ve bought a business recently...
…ask yourself: has the full potential of that merger or takeover ever been realized? (Research from KPMG in the UK suggests that most acquisitions don’t live up to expectations.) Often the very people who were responsible for the merger don’t stick around in the business, and little energy is put into efforts to integrate. This can lead to duplication of services and positions. “Companies grow like this for decades,” says Hill. “You have wild duplication and overlap, and inefficient business processes.” Realizing this – and making the appropriate organizational changes to rectify it – can permanently benefit the business.
 
9 And make sure you deliver
In the past, says Hill: “Businesses have set very modest cost reduction targets and failed to deliver on those.” CFOs can come unstuck if they don’t track the benefits of cost cuts. The program can be mired in confusion, with people claiming they have made savings but no overall sight of what success looks like. “Make sure savings are hard-wired to what you are doing,” says Brennan.
 
Cost should always be on the agenda because, Brennan says, it is about encouraging better quality service and better processes: “It is part of the over-arching business goal and tied to strategy. The market is in a  troubled state and reducing cost comes into sharper focus. That is the challenge for all organizations.” And that challenge falls especially heavily on CFOs.
 
About the Author
This article is republished from KPMG Agenda, the website on advisory and other issues by KPMG, a global network of professional firms providing audit, tax and advisory services.

 

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