A cut above: ill-planned and hastily implemented cost reductions are a recipe for disaster. Mark Warren suggests a formal, structured approach to ensure lasting savings.
| Author | Warren, Mark |
Cost reduction is firmly back on the boardroom agenda for a growing number of organisations. Investors are asking FDs how they plan to cut costs effectively without putting shareholder value at risk. After all, cutting costs is a challenging activity that, if executed badly, can significantly jeopardise an organisation's service integrity, its ability to achieve strategic goals--and even its long-term viability.
It's crucial that any cost reduction programme is aligned with business strategy. A badly planned redundancy programme implemented by one of my firm's clients, a bank, caused many of its most experienced employees to leave, which in turn significantly delayed its strategic bid to regain leadership of the derivatives market. Unless the immediate objective really is survival, any cuts must be sustainable and address lifetime costs.
The implementation of a cost reduction plan entails serious and contentious change, so it calls for the use of programme and portfolio management techniques. Large projects will benefit from the establishment of a cost programme management office (CPMO). This should ensure that plans, risks and interdependencies are recognised, managed and reported in an appropriate and timely way. Each potential cost-cutting initiative should go through a categorisation and gateway process, from identification through to completion and benefit realisation. The CPMO can provide an assurance function here by both challenging and supporting each business unit. It must cooperate closely with the finance department.
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The starting point for a cost reduction programme must be robust data. This normally requires an investment in collating a single set of cleansed financial and key performance indicator figures. Important questions to ask include: is there a single, validated and agreed version of the data? Is there a defined baseline case and basis for ongoing measurement and comparison? Are there common reporting standards?
Accounting policies such as intercompany charging and overhead allocation are particularly relevant here. The notion of profit down to EBITA, broken down by customer or product, can be particularly dangerous if taken out of context or if the cost allocations below gross margin are too arbitrary. Without vigilance from the finance team, there may be knee-jerk reactions to "unprofitable" products and customers. One of my firm's clients once stopped doing business with its largest customer...
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