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Cost reduction programmes: A necessary evil ...or not?

18 May 2009 Ernst & Young

Ask the managers of any profitable company what their key to success is and a defining trend in the answer is likely to relate to their ability to adapt to changing economic, political, social and business environments. Today, this ability is likely to be more relevant than ever before. As a consequence of the global economic meltdown, managers are faced with the unfortunate reality of failed initiatives, enterprises, job losses and profit margins under pressure. Reducing operating and overhead costs has therefore become a key competency in today’s business world, notes Derek Engelbrecht, Retail & Consumer Products sector leader at Ernst & Young South Africa.

However, he stresses that such initiatives should be approached carefully if they are to be successful.

“Studies have shown that most cost reduction initiatives undertaken by companies result in failure. That cost cutting is necessary in increasingly adverse trading environments is widely accepted. However, these initiatives often lose momentum as key people lose focus in or are taken off the initiatives, and commitment levels wane,” he says.

Engelbrecht says Ernst & Young statistics show that a staggering 40% of cost cutting initiatives fail to get off the ground at all. A further 20% fail in the first year and another 16% in the second year. Only 24% make it as far as the third year.

That said, Engelbrecht hastens to add that with the right approach and sound analysis, cost reduction exercises tend to succeed.

“A good approach is to link the cost reduction programme to the company’s long term growth strategy. As implied, this requires the full backing of the CEO and Board of Directors, who should take responsibility for controlling, managing and driving the project,” he explains.

Simultaneously, costs must be aligned with required capabilities for execution against strategy. “Taking out cost is one thing, but impacting on the ability to perform essential functions is another,” Engelbrecht points out.

From the outset, he stresses that management need to understand that cost cutting can and does have adverse effects unless executed appropriately. “Often the wrong costs are cut, resulting in management needing to re-hire people. After cost cutting, an entity has to remain 'effective’, that is, capable of doing the right things and ‘efficient’, that is, capable of doing these things optimally.”

The lack of a focused cost-cutting approach can also lead to long term damage as morale suffers, good people leave and those that remain feel discouraged and unmotivated, Engelbrecht says.

He notes that an intimate understanding of the capabilities of a company, its core products, services and skills form the basis of an effective cost reduction initiative. An assessment of the demands made on these capabilities and whether they are under or over-used is also necessary. Only then is it time to look at how efficiently these capabilities are put to use in the creation or delivery of products and services.

“In our experience, the quality of the client team is another critical factor of success. Having current and future members of the management team engaged in the project signals its importance, while supporting morale and confidence,” he says, noting that the mere mention of a cost reduction exercise is enough to send employees into a downward spiral.

“It is up to the leaders of a company to show that a cost-cutting plan is not necessarily about shrinking a business, but rather positioning it to grow. By showing how savings in one area benefit another strategically important activity, it is possible to gain employee trust and support.”

Many performance management systems make tracking and targeting costs difficult, thus it is crucial to link this aspect to the regular business review cycle. Cost optimisation should be ‘business as usual’ says Engelbrecht, with issues of measurement, transparency and accountability part and parcel of the day-to-day running of the business.


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