In today’s highly competitive world, revenue is not certain, if it ever was. Meanwhile costs are a given – and tend to head upwards, even as revenue may move the other way. People, premises and technology expenditures, which form the bulk of an organization’s cost base, are generally fixed.
Cost efficiency is therefore always important.
But managing costs is not about cutting discretionary lines such as the marketing budget, staff training budget or entertainment and staff welfare budgets. These are short-sighted measures. In the long run, they may be detrimental to the organization's interest by indirectly curbing the growth engines of the business or de-motivating employees.
The first point to remember is that cost management is not a destination. It is a journey. Cost management is not a one-time exercise. Rather it is a discipline to internalize in every level of the organization
And cutting discretionary lines does not change the organization’s basic cost structure and therefore does not result in cost reduction in the true sense.
Any initiative to reduce cost that does not yield recurring benefits should not qualify as a cost reduction initiative. It is merely a tactical measure to meet a short-term target.
I believe that cost management is about creating lasting value in the long run – by the company becoming more productive and efficient, and by bringing about a positive change in the way things are done as an organization.
A journey, not a destination
So how should the CFO go about it?
The first point to remember is that cost management is not a destination. It is a journey. Cost management is not a one-time exercise. Rather it is a discipline to internalize in every level of the organization.
Broadly speaking, there are three steps to managing costs well:
- Revisiting basic internal processes towards the end of becoming more productive
- Understanding where the bulk of the costs lie, with the objective of aligning costs with the revenue objective
- Creating a cost management culture within the organization
Step 1: Process and productivity
Why do we do things the way we do them?
Internal processes determine the pace and integrity of various activities within an organization, leading up to how we service our customers.
They determine speed-to-market, which is a critical ingredient in maintaining competitive edge. The turnaround time of activities also has a bearing on resource productivity and therefore on cost.
Questioning the status quo and reviewing the processes end-to-end, with an objective of understanding where the improvement areas are, is therefore a key step in moving towards a highly productive environment.
By reviewing and improving the efficiency of each of the processes, it is possible to achieve cost savings over a period of time.
For example, if the process for verifying applications for a service is simplified, resulting in reduced cycle time, the number of applications processed per person per day could rise to, say, 75 applications from 50 applications, a 50% efficiency improvement.
This can result in manpower cost saves. Assume the per-person cost is $100 a day. Over a 20-day work month, this translates to $2,000 to process 1,000 applications.
If efficiency were to improve to 75 applications a day, then it will take only 13 working days to process 1,000 applications, saving $700.
This is just one process. By conducting a review of all key processes over time, the organization will benefit on an overall basis.
On the productivity front, it is also important to set productivity benchmarks or targets for each repetitive process within the organization. For example:
- How many customer calls are being answered and resolved by the call center in one hour?
- How many outbound calls are made by the telemarketing unit in one hour?
- How many walk-in branch customers are being handled by tellers per day?
- How many home loan applications are being processed in an hour?
These are all important questions to find the right answers to, so as to set the right benchmarks or targets. Benchmarks can be progressively stretched over time, depending on where the organization stands currently.
Industry benchmarks would also be useful to understand, to measure how far or how close the organization is from them.
Benchmarks or targets should help drive improved individual and group performance. These should also become the basis for resources planning for future.
Step 2: Alignment of cost with revenue
What value is each element of cost creating?
At a basic level, it is important to understand where the bulk of the costs lie. How well do you know your cost base is an important question to answer before you can attempt to influence it.
The more an organization analyzes its cost base, the more understanding it would gain about it, which in turn would help it manage its own costs better.
The following measures are worth considering:
Set up a dedicated Cost Management Team. Led by finance, it should have representation from all departments. This will help prevent the mindset of cost management being a one-time exercise. The cross-functional team, led by the CFO or his representative, could conduct on-going discussions on the key cost challenges facing the business and present findings during the monthly performance discussions with the CEO or business heads.
If an organization is made up of many businesses, then such a team may be set up for each business, depending on scale and complexity.
Establish a robust monthly Cost Report. It is the CFO’s responsibility to make sure that such a monthly report is provided to the business heads. Avoid overloading them with data. The report should contain only details of the key cost lines and the underlying drivers tracked at a business unit level.
The aim is to enable a thorough understanding of the cost base. The CFO can then help the business heads understand which underlying levers need to be worked upon to favorably influence costs.
Understand the efficacy of costs incurred. If the CFO can articulate how much every dollar spent by the business is translating into revenue, it would be made clear to the business head whether or not the expenditure was worthwhile.
For example, how much incremental overall revenue did the marketing campaign of giving away freebies to card customers last year? If done properly, the analysis can clearly tell the business head whether or not to run the promotion again.
Step 3: Culture of cost control
How does one rally the organization?
To embed a cost-conscious culture within an organization takes time, especially if the organization has been run differently in the past.
It needs a lot of communication and articulation. Leaders have to take responsibility to educate foot soldiers about the need to embark on the cost-management journey.
They have to take on the of educating employees about the financials of the company over a period of time, how they are expected to change going forward and why there is a need to inculcate cost discipline in every area.
Mini-targets at various levels should be set and linked to rewards or incentive schemes. Leaders also have to find innovative ways of dealing with the negative energy that a focus on cost management can create across the organization.
Some organizations have successfully installed the practice of inviting cost- reduction ideas bottoms up by rewarding the 'idea of the month' and publishing it in the monthly newsletter. This is one way of creating a healthy atmosphere and engaging every one.
Recognition by the CEO could be another motivator to get everyone thinking in the right direction.
About the Author
Ramesh Narasimhan is the Founder & Principal of Singapore-based Value Consulting Asia, which provides CFO advisory and implementation services. He is also a Senior Director at StraitsBridge Advisors, a specialist firm providing advisory and execution support for CFOs in banks and financial firms.
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