The New Cost-Cutting: Now for the Hard Part

“Five years into the global crisis, most of the simple cuts to costs have already been made,” observes Big Four accounting firm Ernst & Young in its latest Business Pulse global report. “That is now pushing businesses to make tough decisions on how to cut costs without damaging product and service standards."
Is the same dynamics at work in Asia? "It's hard to generalise," says Nigel Knight, Managing Partner, Advisory Services, at Ernst & Young. "Some companies in certain industries have been under intense pressure to get growth as a means of survival after 2008. Others have been on the roll for several years."
Knight and Rob Perry, E&Y’s Advisory Asia Pacific Risk Leader, spoke to CFO Innovation’s Cesar Bacani about how some of the region’s organisations are executing more complicated cost-management strategies after they have exhausted the simple cuts. Excerpts:
Are companies in Asia following those in the West in terms of next-generation cost-cutting?
Knight: Cost-cutting is a very old story in some ways. It is hard to generalize. Some companies in certain industries have been under intense pressure to get growth as a means of survival after 2008. Others – mining and resources in Australia, some of the luxury goods companies [in China] – have been on the roll for several years. Forget cost-cutting; they’ve been on strong growth.
Multinationals are struggling on the top and bottom lines in Europe and to some extent the US. Nevertheless they are still doubling down in key emerging markets like China, Indonesia and so on. There’s still a strong topline focus for most multinationals in this part of the world.
But there’s a story coming here which we in Ernst & Young are seeing . . . Multinationals in Asia are perhaps becoming victims of their own success, in the sense that they now often comprise a large proportion of total [group] revenues and profit. So when there is pressure on headquarters and there’s pressure in Europe, it’s very hard for those leaderships in Asia and in China, in particular, to not be part of that.
Perry: In Australia, there’s been a very strong focus on acquisitions and growth by expansion [in mining and metals]; the Rio Tinto/BHP Billiton type activity that’s been going on for a period of time is very focused on acquisition to drive growth.
Interestingly, in the last 12-18 months, we’ve seen a number of sectors focus aggressively, particularly in the resources sector, on cost-cutting to drive profit growth rather than necessarily the topline growth.
By this time these companies would have exhausted all the simple cuts, such as reducing headcount, wouldn’t they?
Knight: The first round of basic cost-cutting has already happened. A lot of the low-hanging fruits are already gone – introduction of Shared Services model, working capital improvement around purchasing, procurement and so on, basic headcount management, travel & expenses, any discretionary spend.
What we’re seeing now is a level of sophistication. For example, T&E spend was traditionally just putting arbitrary controls on travel and so on. Now the kind of initiatives that are taking place are much more analytics-based.
We’ve been working with a very large pharma company in Asia Pacific, working across countries, across business units, to use analytics to drive T&E spending. That is not the low-hanging fruit; that’s quite sophisticated use of information to do that.
Same with Shared Services. The first-round shared services was very much basic finance and some procurement activities. Now we’re seeing another round, which is extending the scope [to other processes], and also the so-called next-generation Shared Services, which is using the information from Shared Services to also generate further improvements and further reductions.
Multinationals are also looking at their processes much more from an end-to-end perspective, looking to simplify and standardise core processes – procure to pay, order to cash and so on – right across the business. They are trying to take advantage of savings that are not generated in individual business units or individual countries, but across geographies and across business units.
There are two sides to this. One is looking at those processes to generate cost reductions or improvement. The other is very much about protecting the organisation by looking at the risks in those processes.
Are there other second-round cost management areas?
Perry: Aligning the cost of controlling a business with the risk and strategic profile of the organisation is another area. We’ve been able to reduce controls [in client companies] that aren’t focused on risks that matter. We’ve streamlined some back-office type, tick-the-box type [processes].
There’s been an opportunity to eliminate controls that aren’t really associated with adding shareholder value to the organisation, such as those check-the-box controls that actually don’t add to shareholder value, other than the feel-good factor.
Is third-party outsourcing part of the second-round cost management initiatives we’re talking about here?
Knight: I don’t see a big upsurge [in outsourcing]; I see more around internally looking at joining up functions and optimizing processes.
But some companies are definitely looking at that. We’ve been helping companies to select providers. It’s part of the [cost management] agenda.
Is outsourcing cheaper than a Shared Services structure?
Knight: It depends. If you’re moving into that Shared Services model, a lot of companies would prefer to capture the benefits from the standardization of processes first, before handing that on to the outsourcer. Otherwise the benefits go primarily to the outsourcer.
Often there are two stages, where the company looks to standardise and improve their processes first, and then look whether that equation of outsourcing makes sense. Outsourcing may be cheaper, but it’s not a straightforward decision because it requires a lot of sophistication from companies to manage those arrangements effectively. Some companies have actually found that quite difficult to do and they’ve ended worse off in some ways.
You’ve got all sorts of choices as to what you decide to keep within the organisation, which typically are those things that you think differentiate you as an organisation. If you believe that your ability to analyse that information is a core function of the company, then you wouldn’t want to hand that out. On the other hand, anything that is repetitive, non-core, standardised, commoditized, that can certainly be passed out.
Nigel, you pointed out that a lot of the new cost-cutting initiatives are analytics-based. Won’t putting in business analytics systems require additional costs?
Knight: Sometimes you’ve got to spend to save . . . When clients ask our help, we can typically make a lot of progress without a significant new investment on the basis the company’s already got at least the backbone and some kind of business intelligence tools which they have invested in.
If they have made no investment in enterprise business intelligence, then yes, there would be some investment at some point in a suite of tools to do that.
The report makes a reference to optimizing the supply chain as part of the second round of cost management.
Knight: There’s a tremendous opportunity to transform supply chains in Asia to gain competitive advantage, by which I mean making your supply chain more agile, more responsive to local demands.
On the other hand, you’ve got a lot of risk in the supply chain – poor supply performance issues, financial stability of your supplier, and so on. These can also threaten you.
Perry: If I think of Australia, the reliance of Australian entities on China in terms of supply is very high. It’s critical to make sure that you’ve got the right structures and you understand domestic issues in China, whether those are currency issues, rising costs, labour movements.
Knight: There’s a lot of fat to take out of supply chains, just in the way in which companies globalise spending between countries and also in manufacturing strategies. There’s quite a push even in China, which is becoming a more expensive country, to move manufacturing capability to Vietnam, Laos and so on. These are all initiatives that can cut costs out of the supply chain.
But a more important way to look at the supply chain is a way to enable growth. By doing that, by adding scale, you also improve efficiency. There’s scope for saving money, there’s scope for managing risk better, but more importantly, there’s scope to better integrate the supply chain to help enable growth.
The other thing around supply chain is that there is a lot of tax play around supply chain. We’ve been advising a number of global and regional companies about how they can optimise their supply chain not just from an efficiency point of view but from a tax effectiveness point of view. For the CFO, the treasurer, the tax director, that is a big piece.
Are we talking here about transfer pricing, tax incentives to site your headquarters in Hong Kong, Shanghai or Singapore . . .
Knight: It’s around the way you manage and optimise your production, so it’s all about what you described.
When we are with clients, often they ask us to step back and look quite broadly at their supply chain strategy. It covers the risk issues, tax issues, the whole supply chain integration and manufacturing issues, and then down to the more detailed cost cutting and cost reduction around procurement and so on.
Don’t companies run the risk of unintended consequences, though, when they tinker with supply chains and other systems?
Knight: These are not simple things to do. They typically straddle different countries, different legal and tax regimes, different cultures and so on. As I said in the beginning, some of the more straightforward cost-reduction initiatives have already been done.
Now you’re moving into another level, looking at tax efficient supply chain, next-generation Shared Services, use of analytics – these areas are much more sophisticated. They need very careful thinking and the changes must be managed.
What we’re seeing now is that companies that have done some of the basic things are saying, ‘Look, we are not going to continue being successful in Asia unless we are able to further transform our productivity. To do that we’ve now got to embark on much more complicated and more sensitive areas to deliver the next round of improvement.’
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