Often companies launch new products, expand businesses (globally), diversify their portfolio or start new businesses with the aim of enhancing growth and increasing profitability. But in industries which have low barriers to entry and exit, new players enter the market by replicating existing business models and offering similar products and services at lower cost, thereby making it difficult for the existing players to sustain their market share. As the revenue growth per player shrinks over the years, companies explore ways to maintain their profit margins, leading to a situation where cost becomes more important and price becomes one of the key differentiating factors in the market.
In such situations, senior management start hunting for measures to reduce their costs and expenses to improve profitability. Cost cutting (also known as cost reduction) is one of the steps initiated by the Business Managers to improve profitability. The Leaders make an effort to monitor, evaluate and trim their expenditures, and explore options to streamline processes, restructure their organization and cut down flawed expectations. Cost reduction can be a formal company-wide program or limited to a single department. It usually becomes a company-wide initiative during economic recession when their revenue growth struggles and profit margins shrink consistently for quarters.
In this article, I offer my views on few steps, strategies and precautions while taking up a critical project like cost-cutting and run you through some of my thoughts. I welcome your views and suggestions in the comments section below.
(1) First step in the entire process is to identify a target – how much to cut? This requires a lot of deep-dive, number crunching, hour long sessions with your Business Head(s) to determine how much would be an effective range. You might have to identify the broken strategies, half executed business plans or even stop promising opportunities. As we brainstorm the numbers, we need to look at them from the perspective of 5 year strategic plan.
(2) Understand the current cost structure and cost drivers.
- Identify costs and expenses that have returns and those that have little, minimal or no contribution to the revenue. This step shouldn’t be confused with businesses that are new. A new business might demand high investment initially, but may provide consistent acceptable returns over a period of time. As such, a thorough evaluation of the projects is a critical step. Net Present Value (NPV), Internal Rate of Return (IRR) and Payback Period are some of the handy tools for evaluation.
- Assess whether the non-value additional costs are a must. If not, can we do away with them?
- There may be costs that have to be incurred. Can they be reduced through automation, process improvement, low cost country sourcing/global sourcing, re-negotiation with partners, substitutes, etc.?
- Can costs and expenses be deferred? For example, large companies borrowing money through debts can have big recurring expense. Can the interest payment on such obligations be deferred through payment-in-kind?
(3) Explore options
- Recycle and explore concepts like “best out of waste”. Resources like water consumed is often a large part of the cost incurred in running large IT, manufacturing and automotive firms. Rainwater harvesting and recycling can save a lot. Also, constant training and education on controlling use of water helps. Another area that one might like to look at is cost of office supplies like paper. A lot of firms are now “going green” which helps not only in saving trees, but also in cutting down cost. Automated business processes that can accord digital approvals can go a far extent to achieve cost cutting target.
- Another large part of cost is electricity consumption. Usage of energy-efficient systems, solar powered equipments and natural air and light systems helps reduce significant costs. Renewal energy is the key!
- Transportation is another big area. Transporting thousands of employees daily to and from the office using own or leased facilities is very common. Many organizations now-a-days have implemented the concept of work-from-home to curb costs associated with transport. Channel sales operating strategy is another way to serve local customers cost efficiently. Many firms, now-a-days, partner with local players to service their customers on a profit sharing basis.
- Real estate: The cost of space is another big factor. Sprawling complexes with mighty towers equipped with all facilities and arrangements can punch a big hole in firm’s pocket. Again, work-from-home and consolidation can help reduce cost of operations significantly. Data center consolidation is one important factor worth considering, keeping in mind the huge cost incurred in license procurement, support, data security, high performance, high availability, manageability and meeting compliance standard and government mandates.
- Re-look at your resource utilization. Do you really need so many resources at this point? Is there any way by which I can utilize multi-skilled employees? Can we place a more experienced person here and move the aspiring, new yet enthusiastic talent where he belongs to through negotiations? Can we defer the promotions?
Precautions
(1) As you take up the cost cutting project, it’s worth mentioning that such a project is not worth pursuing if the CEO is not leading it. Most of CEOs just delegate this task to one of his directs, who in turn pushes it to their directs. The sad part is that most of these lower folks, who actually design the cost cutting strategy or perform the number crunching, do not have authority other than arranging meetings, generating reports and at the max, suggesting. While crafting the plan, everybody looks at easier numbers – the numbers that do not demand brainstorming.
(2) Another factor to keep in mind is that 10% cost cutting directive across the organization is not something I consider efficient. A 10% reduction in cost (assuming R&D, marketing, sales, operations and workforce) with the aim of restructuring a large business can have significant impact in the way it will operate compared to the impact it will have on a smaller business, which gets to keep 90% of the annual budget.
(3) Cost of people – the concept of “right sizing” – is another area. The big numbers easily catch our eyes and it’s very obvious to start the process here. I say this is how the disaster begins. Firing employees has a cost associated with it and at times, it can be huge. Severance pay, unemployment benefits, rehiring costs, workforce termination lawsuits, month long labor strike are few of them, besides low employee morale, cost of extended working shifts for the remaining employees, etc. Organizations lay off employees without contemplating much on their skills and attributes, thereby losing some of their best talents to their competitors. I know of companies which slashed their workforce with the objective of restructuring and realignment but slipped positions dramatically.
(4) It’s not uncommon for organizations to bring in consultants by paying a hefty, eye-popping fee. These consultants will no doubt offer insights that the Business Leaders may not even have thought of, but they stay with you for few months. Whether this investment will really reap benefits is something we can only imagine.
Also read my article on “Cost Cutting: A Case Study” here.
If you wish to gain any privilege to this blog, please write your message to me through the page “CONTACT ME” by filling in the required details in the form, OR by writing an e-mail to me at nitin@gargfinanceblog.com
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