Optimising your cost structure will save you money

The global financial crisis whose effects in 2009 have received even more prominent headlines, is certain to continue raging well into the year. In the last two quarters of 2008, not everyone was convinced of an impending global downturn, however 2009 continues to bring the realities of such a downturn to countries, companies and individual homes. The scale of local output level declines, reflecting falling local and global demand, has outpaced consensus forecasts and indicates that the depth this downturn may yet to be fully understood. Few companies will argue against the heightened need to prioritise cost reduction initiatives in the current climate. That’s according to Ernst & Young director of Business Advisory Services, Roderick Wolfenden.

Positive global economic growth has been sustained for much of this decade and for most, the corporate agenda has rightly been dominated by growing the top line. As a result of this, executives cost reduction skills are likely to be rusty, says Wolfenden.

But the economic slowdown, accentuated by the crisis that hit global financial markets, means cost reduction initiatives are now firmly back on the agenda of CEO’s around the world. While South Africa has not been as hard-hit as many other countries, in 2008 economic activity had nonetheless slowed driven by high inflation, interest rates and tighter credit availability. Consequently, company executives need to take decisive action to protect themselves from a worsening situation. “Our view is that the larger corporates can benefit by having a clear and robust view on how to optimise their cost structures in order to better absorb the adverse effects of a slowdown in demand” says Wolfenden.

A “robust view” includes four key things: senior executive sponsorship, an enterprise wide view of cost reduction opportunities, alignment of the initiative to the corporate strategy and the careful monitoring of results to ensure benefits are realised. Until now, quite often companies have “tinkered around” with cost reduction, Wolfenden says, “but they now have to address this issue comprehensively”.

If the initiative is not owned at the right level by someone with the necessary clout – such as the CEO, COO or CFO - to drive it across the organisation the programme may be placed at risk with little tangible and sustainable benefits being realised.

The danger is that where profound organisational change is initially met with fear, panic and paralysis, re-balancing enterprise costs can become a reactionary initiative, which is not aligned to the organisation’s strategy. Often companies just react, and focus on one line item such as headcount or one functional area, instead of looking across the enterprise.

“Little or no consideration is given to whether the headcount reduction is in the right places. Companies need to ask: are we reducing costs in the right places or are we targeting areas where we really want to be building our capabilities?” Keeping one eye on the future is important so that when the economy turns, organisations are well positioned to take advantage of the market growth.

It’s critical that cost saving initiatives “cascade through the business”, he says, with specific accountability for realising benefits assigned to specific individuals.

“Unless that happens, everyone talks about the cost reduction exercise, but when you look and try to track the benefits, you discover that very little benefit has been realised.” To avoid this problem, companies need to make sure specific individuals are responsible for particular aspects of the initiative and that it all rolls back up to a senior executive sponsor.

Many organisations lose sight of the cost reduction opportunity that the balance sheet provides, instead focusing only on the income statement. Improving aspects of accounts receivable and payable, inventory and cash management can be more effective ways of controlling costs than only reducing headcount.

Especially after long periods of sustained growth as we have just had, many companies find themselves with a lot of cash tied up in working capital, Wolfenden says.

“Often in these situations you end up holding more stock than you need to. By the time it gets to market, it’s no longer a preferred item, so you have to sell it at a deeper and deeper discount”.

Similarly, managing cash collection better can make a big difference. In times of high growth, companies often take their eye off this ball, but when times are tough and interest rates high, it’s critical to free up cash by reducing any unnecessary working capital investments.

The same kinds of issues apply to managing branch networks. During periods of high growth, companies grow their branch footprints in order to try and capture as much of the growth in their particular market as possible. But when the economy is contracting, consolidating branch networks can deliver cost benefits without necessarily affecting customer service. In some cases customer service can even improve through branch consolidation, and companies can offer better services over a wider range than they were able to with lots of smaller branches.

By analysing the problem quickly using a range of content and industry specialists who look at specific areas with which they are familiar to focus on likely opportunities for cost reduction, Wolfenden says it’s possible to rapidly identify where 70-80% of the cost reduction opportunities lie.