‘Cost reduction’ now ranks alongside ‘any other business’ as a permanent fixture on the minutes of company board meetings. It has become the default setting – or at least the default aspiration – of corporate decision-makers around the world.
Yet the approach to reducing costs can often be highly defensive and short termist, compromising longer term performance and value creation. In any case, knee-jerk cost cutting delivers patchy results; Gartner research suggests that only 43% of leaders achieve their targets in the first year of cost reduction.
Success is more likely if it is reframed as cost optimisation rather than mere cutting
More worrying still, of this 43%, only 11% are able to keep to target for three consecutive years, meaning that over that timeframe the overall success rate is a paltry 4.73%.
Part of the reason the failure rate is so high is that a never-ending cost reduction drive requires businesses to ‘reset the clock’ every budgeting cycle. Much like a crash dieter who sheds pounds quickly at first, sustaining the savings is hard. Success is more likely to be achieved if it is reframed as cost optimisation rather than mere cutting.
A number of key actions can help the optimisation process.
Long-term view
Developing a target operating model (TOM) will help in managing the long-term nature of cost reduction strategy. It needs to be properly understood – and bought into – by all levels. Develop a roadmap for how the business will get there, divided into phases to better manage and control scope, delivery costs, timeline and benefits.
This approach also means that the gains made through ‘invest to save’ will free up cash to support subsequent phases, while also reducing pressure on current cashflows.
The days of cost-saving capital investments running into millions are in the past
The days of cost-saving capital investments running into millions of dollars, pounds or euros are in the past. The speed of technological advancements, coupled with the unpredictability of operating in a global economy, demands a different approach.
Cost optimisation should never require the signing of a blank cheque in the hope of an ill-defined return somewhere down the line, but it always requires good communication and engagement at all stages.
Defining terms
The TOM should provide opportunities to optimise your cost-base, whether at a functional, operational, resource, process or technological level. The key is to understand the nature of these cost-saving opportunities and what they mean for cost reduction, cost optimisation and value optimisation.
- Cost reduction (where savings tend to be a one-off and time to value can be anything between zero to six months) is a short-term, non-programmatic approach to eliminate short-term costs and drive in-year P&L benefits – eg reducing discretionary spend on travel and entertainment, and consultancy fees.
- Cost optimisation (where savings tend to be repeatable, with a time to value of six to 18 months) requires a programmatic approach that’s specific in scope – eg vendor optimisation leading to multi-year P&L benefits. This typically requires a level of investment to deliver, and for the shift to be embedded into company processes, for example.
- Value optimisation (where savings tend to be sustainable and permanent, with a time to value of over 18 months) requires the scope to be business-wide, and for investment to support a programmatic approach, leading to multi-year, sustainable P&L impact such as an enterprise resource planning implementation.
Once your cost-reduction strategy is aligned to these approaches, the next step is a discovery phase. This should result in a series of ways to optimise your cost-base. There is no one-size-fits-all solution, so the options will need to be ranked according to their likelihood of delivering the desired strategic outcome and the benefit they will provide – ie cost reduction, cost optimisation or value optimisation.
It’s important to take a pragmatic approach and ensure that the delivery plan provides direction
Delivery
The delivery roadmap needs to capture all the elements required to make the cost-reduction strategy work, such as board buy-in and agreement on the foundations needed for it to be a success.
It’s important to take a pragmatic approach and ensure that the delivery plan provides clarity and direction for each of the three key phases: finding, delivering and protecting the cash savings. These will need to be underpinned by robust monitoring and controls.
Embedding
Apart from poor delivery and unrealised benefits, the most common reason that cost optimisation programmes don’t last is where there is a failure to incorporate the new model into business-as-usual operations – in other words, the changes and the savings they produce need to be embedded and protected. Vital to this is:
- developing clear measures of success – ie quantifiable metrics that align with corporate strategy and objectives
- implementing and embedding a cost management framework that is integrated into everyday business activities. Performance should be monitored and reviewed regularly by tracking progress against the established baseline and adjusting strategies as needed
- establishing new ways of working with collaborative, cross-functional teams that provide end-to-end visibility and eliminate silos. Achievements and milestones should be celebrated, and new targets set to drive continuous improvement. This could also include the creation of a cross-functional cost-optimisation steering team, whose sole mission is to drive cost optimisation across the business.
More information
The theme of moving away from short-termism in driving organisational performance, and instead embracing driving sustainable value for all stakeholders, is explored further in ACCA research on the chief value officer. Finance professionals have an important role to play in driving this agenda across businesses, government and society. Find out more in ACCA's policy and insights report.
