Cost reduction in the credit crunch

The credit crunch is affecting businesses of all sizes, in all geographies, and across all industries and sectors. The forecast does not look any better for next week or even for next month. In order to ensure your business is still alive and kicking when the economy does improve, and it will, you may need to reconsider your current modus operandi of doing business. In the last few years the buzz words for management teams have been “revenue growth - at all costs”. This was driven largely by easy credit and increased global demand. The fundamentals of running a tight ship and cost containment or reduction has been pushed to the side lines. The discipline and control needed to contain, reduce or rebalance ones operating costs must now be revived. The lack of credit available and the exorbitant costs involved in obtaining it is prohibitive and thus, managing one’s cash flow has become a priority. Cash and not profit is again king, and focusing on cash management will help to constrain and reduce your operating costs.

A review and analysis of your supply chain should be undertaken in order to ascertain where savings and cost reductions can be obtained without damaging your business operationally or from a reputational perspective. In order to be effective cost reduction strategies must not compromise your revenue stream. Changes in your supply chain to reduce discretionary spend, improve demand management, improve procurement, obtain better financing options, reduce working capital cycles and cash conversion cycles as well as streamlining core processes and functions, will all go a long way to ensure you reduce your operational costs and improve your cash management without damaging your business in the short or long term. We will look briefly at some of these concepts to identify ideas to ensure your ship is tightly managed and your costs are efficiently contained.

The focus on working capital and the cash conversion cycle is one of the most essential steps in building and conserving your cash holdings. Your starting point should be to reduce your working capital cycle by reducing your inventory holdings to a shorter period. Reorder inventory only on demand. Thereafter you should reduce the duration of your cash conversion cycle. This can be done by renegotiating credit terms with suppliers by either increasing your credit terms or by agreeing to early payment settlement terms. With your creditors on the other hand, you should shorten their credit terms where possible, apply stricter reinforcement and collection of payments and re-evaluate their credit worthiness regularly.

An analysis should be undertaken of your discretionary or variable costs vs your fixed costs. Variable costs and discretionary costs are the easiest areas to reduce unnecessary spend. Cost justifications should be implemented and managers must be held accountable for all cash outflows. The biggest reason for failure of cost reduction schemes is that businesses do not, upfront, set benchmarks to monitor and measure cost reduction success. The consequences and successes must be visible to all members of staff and adherence must be implemented from the top down. If people cannot benchmark the success of the initiative they are likely to stop trying and get frustrated by what they see as petty unnecessary changes and rules being put in place which make no difference to their positions in the business or the business’s success.

Capital investment projects focusing on growth and other capital intensive initiatives should be reconsidered and where possible put on hold. Be careful only to put on hold those projects which are not going to be detrimental to your business operations if they do not go ahead. Losing out to the competition because of an initiative that you did not implement is not going to strengthen your business in the future, and this must be weighed up against the benefit of the costs reduced. This risk can include reputation risk being increased if a project does not get implemented or finalised.

Financing costs must be critically reviewed. When the external finance was initially taken out, credit terms were good and due to availability the buyer was in the pound negotiating seat. Unless these terms were fixed, this is no longer the case. Renegotiating of terms is possible but it is likely that you will still not be in a great position. Accordingly, reducing your financing to the lowest possible amount is crucial. Cash saved by your cost reduction project and any that which was previously set aside for growth initiatives, could be better used by reducing your external finance. Changing your operating model for capital acquisitions from one of full ownership to leasing or entering into sale and leaseback agreements with current assets can free up cash and reduce your financing expenditure.

Streamlining of core processes to eliminate duplication in different divisions or operations and to ensure overlapping functions are removed and that efficiency is improved, especially vis a vis support functions, can add benefit quickly to your bottom line. Shared service centres and shared functions must be reconsidered at this point in time, particularly with big multinationals operating in cheaper labour or low tax jurisdictions. Sharing of best practice is a well known concept but in fact is seldom efficiently practiced in the bigger environments. By including all staff in the project and granting them the authority and ability to challenge the current business processes by giving the opportunity to provide ideas for change, allows them not only to be part of the solution, which is critical to its success, but can also bring up new ideas which the top management may not have access to.

Flattening of management structures by reducing non essential staff and other non performing staff and increasing performance expectations and productivity can play a crucial, if unwanted step, in the process. Often the greatest cost to a business can be its staff (not only from a salary cost perspective) and if in the worst case scenario your staff complement needs to be downscaled or reduced, this must be done very carefully and very quickly to avoid instability. Uncertainty and instability both internally and in the market will drastically reduce the effects you wish to achieve. An analysis must be performed to ensure that the often massive implementation costs of retrenchments do not outweigh the cost reductions. Retrenchment packages, internal downtime and legal disputes, can completely out weigh expected returns.

The above cost saving ideas are all well known business fundamentals and in fact are common sense ideas. However when a business has been focusing on growth and management team incentives have been based on increased revenues over the past few years, a line in the sand needs to be drawn to change the way the business is operating and the fundamental focus of the management teams. Discipline and control around cash management and cost reductions should be the new buzz words for the year ahead.