With an economic slowdown taking place in some parts of the globe, cost reduction efforts are becoming more crucial for companies seeking to maintain profitability. However, even for enterprises who are not affected by such challenges, reducing costs present a number of strategic benefits.
Most commonly, cost reduction is largely associated with struggling organisations, or those that operate in challenging markets. The most obvious example is the financial downturn of 2008 forced many business leaders to cut costs and dissolve various functions just to keep their business afloat.
However, many businesses today are recognising the potential strategic benefits of reducing costs, and have focused on cost-cutting as a way to drive growth, rather than just as a way to survive or avoid insolvency.
According to a recent report by Deloitte, the top cost reduction drivers are ‘gaining a competitive advantage’ and ‘required investment in growth areas’. Moreover, the next highest drivers are ‘international portfolio performance’ and ‘reduction in consumer demand,’ which are more defensive in nature.
Christine Ahn, Principal Consultant and leader of the shared Services and Enterprise Cost Management, Deloitte Consulting, explains that different situations present different requirements and priorities in managing costs. “A company in distress should focus on short-term survival, while a company that is growing steadily should seek ways to strengthen its competitive advantage through smart investments and possibly M&As.”
Macroeconomic concerns remain the top external factor that can influence a company to drive down costs. “There’s a confluence of factors that can drive us to reduce costs in the company,” explains Koshal Mundhra, Group CFO, Dhofar Global. “Some of the main considerations include the current state of the economy, along with the profits for the year and return on investment. However, there are some positive motivations behind any cost reduction initiative of an organisation, which include boosting a company’s competitiveness and improving its profitability.”
Reducing costs strategically is important to the C-level’s agenda, and if done successfully, paints the CFO in a great light. This enables organisations to remove activities and processes that do not drive business value, assign or on-board the right people to complete them, and focus on more important resources.
Mundhra further explains that when cost reduction efforts are done progressively, they can lead to greater gains in value creation. “To do so, an enterprise must employ informed strategies that will drive out costs and enhance efficiency,” he says. “Careful and in-depth analysis of the current market situation and its effect on a company’s profitability and overall operations must guide cost-cutting programmes. Ultimately, what is crucial is thinking beyond short-term savings and focusing on some of the key dimensions of the business to determine core cost drivers, and deploying appropriate measures accordingly.”
CFO’s are expected to take the lead wheels in navigating the company towards a more profitable future. “The CFO’s role is more diverse and challenging and is evolving to that of an architect of business value and managing complexity while controlling costs,” says Professor Chris Rowley, Cass Business School, City University London. “CFOs are also under greater pressure to ‘save to grow’, which means to cut costs while simultaneously driving growth and ensuring control in the context of economic uncertainly, regulatory requirements and investor scrutiny. However, more traditional approaches to cost savings, such as streamlining processes, headcount and external spend, have lost impact with over-use, requiring more strategic actions.”
According to Prof. Rowley, there are quite a few challenges that CFOs face in taking on cost reduction responsibilities. The weaknesses in the role could stem from a lack of strategic talent and planning, being bogged down with operational issues and lacking support.
Any cost reduction initiative needs its context, parameters and desired outcomes to be clearly understood. Lowering costs can definitely cause major transition within an organisation. Therefore, during this period, it is imperative for the finance function to optimise all relationships with all the key stakeholders of the company. A big part of a CFO’s role in this situation is helping everyone within the business to understand the operational decisions required to improve its financial position. Therefore, the finance chief must aim to retain business confidence and avoid surprises during this period.
Prof. Rowley suggests that businesses integrate these three streams of thought. “First, the ‘Four Faces of the CFO’ (Deloitte) framework, which distinguishes a dichotomy of CFO roles: ‘traditional’ (steward, operator) and ‘new’ (strategist, catalysts).
“Second, they can look at Dave Ulrich’s model of the different HR practitioner roles which can increase a business’s competency even while it is undergoing operational changes — strategic partner, change agent, employee champion, administrative expert; revised to strategic business partner, capability builder, change champion, technology proponent, HR innovator and integrator and credible activist. What all these models have in common is the idea of a spectrum of the CFO and HR roles, moving from reactive and implementers to proactive strategists, in turn becoming change catalysts and business partners. Third, to move away from universal, blanket approaches by adding the Ulrich and Rowley framework of the ‘3Cs’ — context, culture and competence to fit the CFO’s cost reduction strategies,” he says.
Finance heads are encouraged to establish a strong symbiotic relationship with the HR function to ensure both internal and external support in employee resourcing and development. “Doing so will also help HR’s search for its ‘Holy Grail’ (the same one for CFOs) of importance, which is about not only being involved in strategy but also creating measurable impacts,” says Prof. Rowley.
Mundhra agrees with this notion, explaining that it is vital for CFOs to maintain regular internal communications with employees and other stakeholders during the course of the implementation of cost-reduction measures. “They must be flexible enough to adapt to various strategies according to the different requirements of each department,” he says. “It is imperative for CFOs to take precautionary measures when implementing such strategic decisions. Cost reduction must be implemented gradually and re-adjusted according to the current market situation. The most common mistake is haphazardly laying off people or dissolving departments during these times, which does not always result in a drastic outcome.”
It is crucial to keep in mind that cost reduction efforts need executive commitment and expertise. It requires a consistent and measurable programme and the value of communication during this period in the company cannot be over-emphasised.