Keeping your eye on the ball

The recent benign economic conditions have seen cost management take a back seat. When the economic cycle turns, companies tend to become more resourceful and focused on cost. They willingly consider tools such as outsourcing, shared service centres and process standardisation. But, with revenues up, cost-cutting measures slide. However, organisations need to manage costs to protect competitiveness.

When KPMG commissioned the Economist Intelligence Unit (EIU) to investigate corporate attitudes to cost cutting, it found that almost two-thirds of companies set themselves cost-reduction targets as low as three per cent. Yet, shockingly, only eight per cent manage to achieve or exceed these low expectations. It seems that as profits and revenues rise, companies increasingly lose control of costs. What is more, they allow it to happen.

The survey of 427 senior executives at leading companies around the world takes a detailed look at how companies address their cost structures. It found that costs are an issue – but, with revenues rising at a faster rate, they do not top the agenda. In fact, 42 percent of those surveyed admit that revenue growth has distracted them from cost savings.

Mind the gap

Corporates cannot survive on revenue growth alone. They have to manage their cost base at the same time as growing revenues, or risk leaving a gap for more cost-conscious and agile competitors to sneak in and steal market share. Look at how nimble-footed, low-cost airlines seized large volumes of the market from cost-bloated operators. But the good times will not last for ever. Steps taken now to manage costs mean that companies will not resort to less well-thought-out survival tactics when the tide of fortune turns.

Where increased profits and revenues mask a bloated cost base, companies leave themselves wide open to predators, especially when private equity (PE) buyers are on the lookout for deals. The multiples that PE buyers will pay indicate that they are increasingly looking at operational cost savings as well as financial engineering. Take the potential bid for Sainsbury's, where bidders almost certainly built substantial savings into their cash-flow projections.

The temptation to focus exclusively on revenue growth is possibly best illustrated by Asian firms. The survey shows that they are the most likely to let cost cutting take a back seat to revenue growth. Unlike their North American counterparts, they have seen faster rises in income over expenses.

This disparity has been the result of the rapid escalation of Asian GDP in recent years. The focus has been on revenue growth and the need to gain market share while it is available. Many of these businesses have not even had to consider cost management. However, history has repeatedly taught us that high-growth economies are most exposed to global economic downturn. Organisations that successfully balance the need to gain market share with building a solid and sustainable base will be the long-term winners.

Whose problem is it?

Accountability for cost cutting should be everyone's concern. While CEOs and CFOs may not involve themselves in the nitty-gritty of cost initiatives, they need to illustrate buy-in and leadership. Reducing costs that are built into a business model means changing embedded culture and practices. It takes clear leadership and communication from the board to alter practices so that they will deliver long-term benefits. It is advisable to delegate programme management for these initiatives, but sponsorship and leadership must come from the very top of the organisation.

However, the survey also revealed that 58 % of companies do not build cost incentives into employees' rewards. Cost reduction exercises can be difficult and painful for both the organisation and the individual. However, without some sort of mandate or incentive from senior management, why should individuals stick their heads above the parapet and court significant personal risk?

How to manage people costs

Over the next three years, according to 74% of companies, it is people-related costs that are most expected to rise. This comes at a time when companies are already increasing employee remuneration and benefits to attract and retain scarce talent.

There is an arsenal of tools that companies can use to manage their people costs. Initiatives such as offshoring and outsourcing onshore can help companies take advantage of the economies of scale available to specialist suppliers. Companies need to look at these tools as part of the mix of how they manage their people costs – and to recognise that they are not suitable for all.

A key challenge of managing people-related costs is that as our economies have developed, people costs have become less variable. Senior managers continue to look for ways to flex their costs in line with revenues.

Among professional services firms, where the cost base is substantively made up of people-related costs, there is a growing tendency to introduce a greater element of variable pay into reward structures. This not only ties the individual more closely to the performance of the organisation by giving higher bonuses to those who perform better, it also reduces the risk of mass waves of redundancy and hiring that characterised many firms in the early 2000s.

Other organisations 'variabilise' their wage bill by increased use of bought in or contracted labour. And, increasingly, they are looking at doing this in a more structured way, often via partnerships and alliances to buy specialist resources on tap when they need them. When demand declines the tap is turned off. This reduces the need to buy in expertise and to honour contractual employment conditions.

Future vision

Rising revenues have had an analgesic effect and lured companies into a false sense of security. Like the fad dieter who cuts out crisps but not chocolate, cost-cutting exercises often target just one problem area, and the benefits are short term. An organisation that resorts to quick fixes and does not embrace a cost-cutting culture, risks becoming cost-bloated, ripe for takeover, or simply too cumbersome to react when a nimbler competitor steals an opportunity.

The point is that it is not a choice of raising revenue or cutting costs. Although the balance of attention may, at times, favour one or the other, both are imperatives. If you take your eye off the cost-management ball, expect to feel the pain in future years.

Those organisations which recognise that costs are driven by their operating model and that it can be turned to competitive advantage, can create a culture of cost ownership. In these organisations, the way things are done is challenged by all. Everyone feels a responsibility for cost management and recognises that it is a vital component of securing a better future for all. Until then, nine out of ten companies will, according to the EIU survey, miss out on major opportunities to boost profits.

Tim Jones is a global advisory partner, KPMG

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