Short-term cuts are easy; but making them stick is more difficult. Sales, general and administrative (often grouped as ‘SGA’) prove to be particularly intransigent. While manufacturing efficiencies have improved in recent years, SGA has remained more or less at same levels.
The reasons given, according to research conducted by McKinney’s in the UK, is that most organisations fail to conduct a thorough bottom-up examination of what should be cut and hence identify the true drivers of cost. In the midst of a crisis, senior management look for easily available areas to cut and often, line management apply draconian targets over the medium term in an indiscriminate fashion across ‘cost centres’ without discriminating between those that add vale and those that aren’t as productive in terms of use of capital. Others use inaccurate and incomplete data to cut costs, thus missing opportunities to make long-term effects
There is no silver bullet to get cost cuts to stick, but there are five ways managers can make a difference:
1. Improving accountability
Few would dispute that accountability is necessary for the cost management exercise to succeed. The CEO and the CFO must be highly visible proponents and provide critical energy and motivation but this is not in and of itself, sufficient. Most cost management occurs at lower levels of the organisation. In one large multinational the CFO had little information as P&L made it difficult to analyse for example if freight costs had increased it is was difficult to analyse whether this was due to rises in direct freight costs or through third party providers in sales.
The company resolved that those with the decision making power had to be accountable. For example a sales manger may ultimately be accountable in deciding whether it was necessary to travel interstate for a meeting or whether a video conferencing solution was the choice. The people responsibile for costs need to be the same people who are paid on performance.
2. Making new policy
Managing to a ‘number’ results in flawed decisions; a more enduring approach should be around setting new policy. Such a policy can come from external benchmarking. While these may be too general to be useful (for example when looking at a specific such as sales travel expenses) internal benchmarks are easy to get and give managers more power. Here, mangers can analyse major categories and then set aggressive targets. To make them stick they would reference to the benchmarks, highlighting individual managers who may need ‘educating”.
3. Don’t let formal accounting behaviours get in the way of cost reduction.
CFOs may track accounting data; it can be a useful starting basis. But to get meaningful data without having multiple data systems and inconsistent accounting practices, may require some new data which should accessible by a cost controller or manager. This may require the CFO’s office to assist.
4. Clearly articulate the link between costs management and strategy.
Strategy must lead cost cutting efforts and not vice versa. History has shown that those who took an across the board cost cutting exercise are less confident as to the cuts could be sustainable. Cost cuts can have unintended consequences on the company as a whole. To create value through cost cutting requires deep knowledge of, for example selling costs and R&D. One method to ensure that the strategically important areas do not get ‘hurt’ is for managers and the CFO to understand at a very specify level the return on the capital invested ROIC and the growth of the market in which the company plays. Mapping costs like this will indicate where value can be extracted while cutting cots in other, unproductive areas.
5. Treat cost management as an ongoing exercise.
Most companies treat this as a one-off effort to produce short term profit targets. One off exercises do not require internal capability building; a better approach is to use the cost cutting to build competencies rather than just cost reduction. Cost management programs need to be scoped as two to three year initiatives. Companies need to improve their process and capability if they hope to reduce their costs in a sustainable manner. A capability in cost management is a useful outcome.
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