Reaping the Rewards of Cost Cutting
In these days of insecurity and uncertain futures, the tendency is to manage for survival but the smart business leaders are actively hunting for profits.
And they are doing this without launching costly new initiatives or major capital investments. Seems difficult? Only if we are bound by the traditional approaches to profit growth.
Take the case of a business with 50% margin and a 10% bottom line profit. To double the profit to 20%, business mathematics would suggest you could try a range of approaches from doubling your sales (not easy in these days of fierce competition) to improving the margin by as much as 20 points through better productivity.
In most cases, this may involve shedding jobs at the risk of losing valuable corporate memory, not to mention the attendant social costs.
Often overlooked is the profit opportunity that lies hidden within the operating costs of most businesses.
In ERA's work with organisations, of all types and sizes, right acoss the various economic sectors round the globe, it never ceases to amaze us the surprisingly large values which can be unlocked from business operating costs.
What's more, the value release goes directly to the bottom line. Even though every business nowadays claims to manage their costs prudently, many are continuing to over pay - by as much as 75%.
Even a saving three times smaller would have been enough to double the net profit in the above example.
Such are the possibilities of cost reduction management.
But, how does one achieve such staggering results? Essentially by following a three-step process:
Step 1 - Challenge demand internally
The first step in capturing value from costs starts with vigorously questioning the demand for the product or service being purchased.
Is it a strategic or an operational cost? an we eliminate the need for this cost altogether? If it is absolutely necessary, is it needed as frequently?
Is it worth paying more for additional service and/or quality?
Is there a clear business case based on total cost of ownership? Can we pay for use rather than pay to own?
Step 2 - Get the right supply relationship
Next step in the process is to get the fundamentals right with the supply relationship.
An optimal relationship creates value for both you and your supplier because it delivers value to the end user - who is after all the ultimate customer for both of you.
In building supply relationships take care to avoid extremes.
It is unwise to base supply relationships on blind trust.
It is equally unwise to take a "winner takes all" adversarial stance. Be a professional sceptic and check out the supplier assertions.
Make sure you are only paying for what you need and negotiate to eliminate unnecessary bells and whistles.
You should be fully aware of your cost analysis to help identify excessive margins in supplier pricing.
At the same time, treat the supplier as a partner in your business and work co-operatively to identify savings.
Step 3 - Improve supplier value creation
Sustainable value from the supply relationship does not arise by you simply pushing your costs upstream to the supplier.
True, you have moved the costs out of your business but the supplier is now burdened with them.
Such a situation is not very tenable in the long run. On the other hand, when you and your supplier use innovation and/or technology to create new value, it is lasting and can benfit both parties.
Proactively work with your supplier to identify such value.
But how can you, as the business leader, check whether opportunities of this magnitude - to release profits from costs - exist within your business? Here is a quick check list:
Q1: What are the facts about your operating costs?
History plus history plus history is trend. Calculate your operating costs as a percentage of your sales over the last five years: is it going up, staying the same or coming down?
Can you explain the trend from what you know about your business?
If you can't, this should quickly alert you to possibilities for releasting profit from your costs.
Be alert to inexplicable increases even if they appear to be small.
Q2: Who has accountability? What are the KPIs?
Take a list of your operating costs and write next to each line item who you hold accountable within your organisation for managing it.
In business, you need clear linesof accountability to produce targeted results.
Who do you look to within your business to reduce (not just contain) operating costs? "Cost management is everyone's job" is a slogan. Apart from slogans to assure results, you also need unambiguously articlated goals and clear lines of accountabilities.
Remember, unlike assigning accountabilities for functions such as making sales, collecting cash and preparing accounts, it is sometimes difficult to assign accountabilities for managing some operating costs.
For instance, operating costs such as communiation or printing costs are incurred right across the various business silos and processes.
Whoever you hold accountable should have the authority and capacity to act for the entire company.
Their accountability and the related KPIs should be in their performance contracts.
Make sure you review this regularly as part of their performance evaluation and feedback process.
If there are particular costs against which you can't clearly identify who within your organisation is accountable for managing them, chances are you have identified potential areas of profit opportunities.
Q3: How is performance measured, reported and reviewed?
What performance measure do you rely on to check that your operating costs are being controlled?
The aphorism, "what does not get measured - does not get done," is true.
The problem is what metric you use. If you are drawing comfort from seeing positive variances either against prior period or budgets - beware.
Internal, historical measures tell you only how well you have done against your own standards.
They don't tell you whether you are optimising performance or even how well you are doing in comparison with businesses of similar size and type.
If there are particular costs where your only available metric is historical and/or internal, you have stumbled on a potential profit opportunity.
Q4: What is the process for incurring cost?
Get people to list the suppliers you are using against each cost line-item. If there are several suppliers against a particuilar line-item potential exists for value capture through streamlining and innovation.
If people are telling you, "we buy things as we use them," - it might not always be because they are being prudent.
"Ad hoc" purchasing generally ends up costing more.
If supplier contracts are being entered into, are you satisfied that your people have the necessary "state-of-the-art" market knowledge, tendering capabilities and negotiating experience?
This is particularly important if the item being contracted is not part of your core business and consequently, your staff is not well versed with the intricacies of the supply market.
If you have had the same supplier for a long period, they should also be proactively identifying profit opportunities for you through innovation.
Some final thoughts
We all have the propensity to believe what we like to see happen in our business is actually happening.
Staff members, however well intentioned, also have the propensity to tell the business leader what he or she likes to hear. Don't let that happen to you. vigorously seek out evidence that your costs are being reduced.
Complancency is a serious obstacle against achieving just results.
Don't let your organisation wait for some catastrophic event toforce action. Take the initiative. Set high standards. Expect the best from your organisation.
At ERA, for every $1million of costs under management we put $200,000 on average on to our clients' bottom line. Of course, we tend to get the more difficult and complex cases but this should give you a yardstick of what may be possibile within your organisation.
After all, it's your profit - you have worked hard to earn it. Don't let it leak out of your business!
Keith Ketheeswaran is an Associate with Expense Reduction Analysts in Australia. ERA is a global, franchised cost management consulting group that helps large companies achieve significant reductions in their business operating costs. More details can be found at http://www.expense-reduction.net
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