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Table of Contents
- Focusing on how to reduce cost, rather than how much
- Contracting and Procurement Strategies
- Utilising Industry Cost and Internal Data to drive targeted cost reduction strategies
- More effective utilisation of working capital to reduce costs
- Purchasable Annual Leave
Industries and business are inevitably faced with periods of economic uncertainty where they are forced to make difficult decisions with regard to how the business operates and where cost reduction can be found. Often, many of the businesses opt for headcount reduction as their primary initiative for reducing cost which can place a significant human impact on your staff.
It is often these deep headcount cuts that provide a negative long term impact. This impact outweighs the short-term cost savings associated with headcount reduction.
Successes in cutting costs erode with time, this article will examine strategies and techniques on how to implement some cost control quick wins as well as define some of the strategies that can be utilised in the medium and longer terms.
Why is it difficult to make cuts stick? It tends to be because of two key reasons;
- The cost reduction programs don’t address the true drivers of costs or are simply too difficult to maintain over time.
- Those tasked with making the reductions lack the understanding of where to make meaningful cuts that will deliver over the longer term.
Companies don’t cut costs because it’s an enjoyable exercise. In almost all instances the business is under significant pressure, whether it be external forces, commodity prices, business competition or simply a slump in sales growth due to weak economic conditions. In all the above-listed scenarios, understanding what drives business cost, will help define your ideas and initiatives to make meaningful and long-lasting reductions in cost.
Focusing on how to reduce cost, rather than how much
Cost reduction methods lose effectiveness over time because senior management traditionally starts the campaign off by saying ‘how much can we save’ ‘how much do we need to cut’, then leaves the decision on how to meet those targets to line management. Inevitability the low hanging fruit (headcount reduction) becomes the primary measure of reaching that cost target for the business. The general assumption from senior management is the line managers should have a more detailed understanding of what are the key cost drivers in the business. While this is true in some instances, there are also many instances when the line manager’s decision to make cuts has resulted in flawed decisions, such as delaying capital expenditure, cutting costs in a manner which undermines revenue generation or simply shifting costs from one accounting category to another.
A more lasting approach would be to challenge the way people think about costs in the business;
- Corporate credit cards are always interesting as people traditionally never view their company’s money in the same way they view their own. Removing credit cards and having employees claim the expenses shift the employee’s mindset to ‘do I really need this?’ it further allows for additional scrutiny when they submit their expense claim.
- Travelling for meetings is another simple and effective means for reducing both direct and indirect cost, today almost all offices can video conference, whether it be through a dedicated video service or via Skype. Video conferencing eliminates the requirement for travel costs but also negates the requirement for employees wasting time travelling to the airport, flying to the destination and so-forth, ultimately also increasing their productive time whilst simultaneously reducing cost. If catering is traditionally provided to these meetings, engaging in a videoconference further negates the requirement for the company to provide catering.
"Simple shifts in employee thinking can have flow-on effects in helping to reduce costs."
Contracting and Procurement Strategies
Contracting and Procurement (C&P) strategies done badly can cost business significant sums of money. Done well, however, they can help shape business strategy and implement contracts that mitigate business risk and exposure. I have seen C&P managed with expensive ERP systems and I have seen techniques where it has been managed with an excel spreadsheet, the key requirements for quality C&P are;
- Procurement Policies that outline spend thresholds and the requirements to spend up to the defined thresholds.
- A governance and approval system that aligns with the policies and methods implemented
- Ensuring those with the authority to spend company money are held accountable for their actions.
When a business is looking for ideas to make cuts, the procurement function is the one department that should be able to provide an exceptional understanding of why and how the business is spending its money. Remember procurement is a service delivery function, that fact that they are buying gold plated hammers is not their fault, as someone is asking them to buy gold plated hammers. They should be able to tell you that metal hammers can perform the same function as the gold-plated hammers, for a 10th of the cost.
A recent client review conducted by Strategy Source Connect revealed that 45% of their annual spend was across two key categories. However, the client was engaging over 300 unique vendors for those two categories where 10 were more than adequate to facilitate supply.
Phone and printing costs were two categories that were in the top 10 cost contributors and were not aiding in revenue generation.
Understanding where the key expenditure areas were allowed us to control costs by using methods such as the following;
- Categorise the spend
- Define the number of vendors per category
- Review the overlap, what items were the client buying from multiple vendors?
- Establish what items the client was buying that was required for revenue generation
- Conduct tenders for the categories and their associated items to consolidate spend with the most cost-effective suppliers.
- Establish 12-24 month contracts with those suppliers to lock in the reduced rates.
By following the above 5 steps, a 30% reduction in addressable spend was achieved for the client. These above steps can easily be applied to any organisation in order to help reduce costs.
Utilising Industry Cost and Internal Data to drive targeted cost reduction strategies
Understanding where you sit in the industry in which you operate can be very illuminating with regard to understanding where there are potential costs to be stripped out. It can also be very important where possible, to understand if the rates you are being charged from suppliers are market competitive.
As an example, a recent oil and gas client of mine requested a review of one of their functions. After examining their spend data and field execution strategy it became apparent that their costs, while lower than the industry standard, were still higher than it should have been and exposed the business to a level of risk that could be lowered through astute contracting.
The key ideas behind the strategy were to attempt to consolidate as much spend through a smaller group of suppliers as practically possible. Additionally, there was a desire to over-engineer a number of solutions which were adding unnecessary cost. The consolidation and simplification technique worked, and the initiative was ultimately able to reduce execution costs by nearly 50%. This would only have been possible through having an understanding of industry and market costs.
"The consolidation and simplification strategy worked and was ultimately able to reduce execution costs by nearly 50%."
More effective utilisation of working capital to reduce costs
The utilisation of working capital is not a subject one generally associates with strategies on how to control costs but can play a vital role in reducing cash flows.
A review of a recent client’s expenditures noted a fleet of 17 work utility vehicles that were financed for their remote operations teams. The fleet itself was unremarkable however the mechanism in which they had financed the vehicle and the associated outgoings were staggering.
The table below itemises the cost associated with the fleet based on the initial review.
What we discovered, was that on average, the business was paying $1260 per vehicle, per month, not including fuel and toll charges. The reason these charges were not included in the comparison, is that we knew a more advantageous position could be negotiated through a fully maintained operating lease (FMOL). The FMOL would not include fuel or toll charges however it would cover all associated running costs including maintenance, tyres and registration of the vehicles.
After developing an intimate understanding, and ideas of the baseline costs and business requirements, we went out to a number of fleet providers and asked for multiple vehicles and multiple lease periods for the vehicles in order to obtain an understanding how the best value could be derived for the client and to ensure they were not signing up to a very long term deal they could not get out of, should it be required.
After reviewing the various proposals, the FMOL selected has been compared to the initial cost outgoings of the business.
Breakdown of FMOL costs in business
For the above comparison, fuel and toll charges were made to be ‘like for like’, the rest of the costs are a direct comparison and highlighted the business could save more than $100,000 per year, simply by shifting its vehicle financing strategy. Further savings were generated through the ability to deduct a greater portion of the lease costs as a business expense as compared to the vehicles financed through loans.
In some examples it is difficult to know if the business is paying for services that are at a fair market value or where there is room for improvement. Initiatives that can help you identify potential problem areas include;
- Seeking out expenses that help drive revenue for the business. High business costs that don't aid value need to be scrutinised.
- Review company policy during periods of growth. Company policy tends to allow greater levels of discretionary spending - during periods of austerity not everyone in the business needs a mobile phone, company vehicle and petrol card.
- Introduce new policy and process. In smaller organisations delegations of authority and spend thresholds are not always defined and can allow miscellaneous spend to accumulate, especially on company credit cards. Putting thresholds and approvals allows for the monitoring and scrutinising of cash outflows.
- Empower an employee or team to be accountable for the purchasing of goods and services. This enables employees to review and hold each other accountable, without tying up management in approving purchase orders. The individual or teams can be measured on key performance indicators set by management to ensure they uphold the requisite standards set.
Where the business is unsure or cannot obtain information to determine whether their cost baseline is inline with industry norms, consultants are excellent tools whose methods and techniques can be utilised to provide valuable insights and strategies.
Cost comparison between finance and FMOL for business vehicle
Purchasable Annual Leave
While all the above strategies and ideas have focused on controlling the current costs or operational strategies employed, there are alternate options if those mentioned above are not an option to you.
For example, PricewaterhouseCoopers implemented a flexible working programme for their staff which had been in place for 4 years when the company started to feel pressure from a serious downturn in the industry. Rather than opting to reduce headcount they decided to offer additional purchasable annual leave for an extended period of seven months.
The offer was made to 4500 employees and was communicated in a transparent way, so that each employee knew the reason for the offer – to avoid having to take the redundancy route.
The results of the offer were significant. Ninety per cent of the 4500 employees accepted the offer to take between 10 and 15 days’ unpaid leave.
Exactly how much money the strategy saved the company – and in turn how many jobs it saved – is difficult to quantify. However, with more than 4000 employees taking an extra 10 to 15 days unpaid leave it’s easy to say it would have a huge impact on overall savings.
Organisations shouldn’t overlook the substantial benefits that can come simply from identifying key activities and optimising those activities.
As an example, a retail client of mine was required to reduce cost and optimise its current operations, due to facing significant headwinds as a result of the current downturn. To control costs was essential, but the retailer feared driving sales even lower if it cut in the wrong places. It began by working out which activities were essential for a distinctive retail experience and which would be most easily damaged by cost cutting.
One critical activity was organising in-store promotions (not just sales but also new-product promotions and seasonal events), from which the retailer derived more than 10 percent of its sales. Organising these activities involved highly elaborate processes: every region of the business and several corporate functions had to sign off on each promotional program, so across-the-board cost cuts could easily remove the people who understood how in-store events worked. By identifying this process as both crucial and vulnerable, the retailer cut costs with minimal impact.
Generic optimisation activities can include;
- Using the company's bargaining power to drive down suppliers costs;
- Make use of economies of scale (buy materials in bulk);
- Invest in technology to increase production efficiency;
You can also look for opportunities to optimize value by:
- Bypassing cost of distributors and dealers by selling directly to customers;
- Replacing certain value chain activities with technology;
- Eliminating low-value activities;
- Relocating facilities to lower shipping or handling costs;
- Offering frills-free experience (bare-bones product or service – anything other than essential is charged extra);
- Limit your product line;
If these ideas, activities and techniques cannot be conducted in-house, an experienced supply chain consultant or contract & procurement professional should be engaged to help facilitate the optimisation process.
Most companies treat cost management as a one-off exercise driven by the need to manage short-term profit targets—and some of these exercises do succeed in the short term because of constant pressure from the CEO or CFO. Yet such hasty cost-cutting activity typically goes into reverse once the pressure is removed and rarely results in sustainable changes for the business.
Companies should start any cost-cutting initiative by thinking through their objectives. It is far too easy to say let’s cut costs by 20% and reduce the associated headcount. Setting in place clear and meaningful objectives for the short and longer terms identifies the goals that all employees are striving toward and creates a unified plan to meet those objectives.
Where possible, set the objectives and associated strategies to take advantage of current and projected marketplace trends, such as being able to capitalise on lower supplier costs to decrease your project or pass-through costs to clients. An important part of the analysis and objective determination is to understand a company’s financial situation and the range of potential outcomes under several different scenarios.
Secondly, within the resulting strategy, take time to understand which activities and methods drive value, such as the number of workers, safety metrics, or project costs - define which activities do or could make the organisation competitively distinctive. Organizations should invest in value-creating activities and cut costs in others while ensuring that these activities are focused on meeting the set objectives.
Finally, use the cost reduction program as an opportunity to build a competency in cost management rather than simply cutting costs. Cost-management ideas and programs need to be scoped, with ranging time frames from 3 months to three-year initiatives rather than as immediate-term efforts with no thought given to the longer-term objectives.
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