Major deflation of economic activity is being masked by aggressive central bank intervention worldwide, and that intervention cannot successfully mask the problem indefinitely. Organisations wanting to remain profitable must take action on all fronts to respond robustly to the risks. Simple cost reduction exercises don’t work: a strategic approach to the management of costs is essential to any sustainable profit improvement programme and this needs modern methods. Ron Yellon of Auditel, pioneers of cost management disciplines over the last 20 years, shares his expertise.
An Aging Population
My generation, the Baby Boomers, are slowing down their earnings, heading into retirement and were shocked by the financial crisis in 2008 into aggressively saving, rather than continuing to consume. The next generation is much smaller and can’t possibly make up the slack. In effect, demand is going down and can’t be pumped it up sustainably. Retired people don’t borrow money, start businesses or spend like they have a job when they are on a limited budget. Japan, an economy in its third decade of deflation with an aging population that is slowing its spending pattern, and far more aggressive bond buying and money printing has had little positive effect.
Less consumption means fewer sales
But what is good for you as an individual can be very bad for an economy. For instance, it is a solid long-term wealth strategy for individual families to save every penny they can save, pay off all their credit card debt, drive an old car and live three generations deep in one house. But if we all did that consumption of iPhones, housing, clothing, furniture, movies, restaurants and cars would dramatically slow down. Less consumption means less profit for companies which in turn lay people off. Those workers, being unemployed, cut back spending; less spending takes us deeper into recession and ultimately into a depression.
Devaluation
Central banks are pouring trillions into the financial system and while this may have saved a fall from the fiscal cliff what happens when the music stops, and there are fewer chairs to grab? Despite the rhetoric of open trade, successive countries have set their stall for a currency freefall in a competition for export growth. It’s a race to the bottom that nobody can win. The only responsible approach is to prepare for the end-game with strategies that will serve us well.
Lower sales need not equal less profit
Apart from improved focus on margins, with sales harder and harder to come by for the bulk of businesses, it makes sense to turn serious attention to costs.
If you could reduce overheads by 20% in your organisation, and keep them down into the future, while at least maintaining value for money and without diverting resources, what would that mean for your bottom line? How much extra sales effort would you need for the same impact?
Factor in improved control, better risk management, strategic gains from better relationships with your suppliers, and you can understand the appeal of tackling costs effectively. Releasing time and money for growth projects adds a further accelerator to performance.
Cost are on the boardroom agenda
A recent survey by Management Today, sponsored by Auditel, the UK and Ireland’s leader in strategic cost management, found that 60% of CEO’s now champion cost management. It is on the boardroom agenda of 82% of respondents. However only 30% of survey respondents described the cost management measures in their organisations to be very strategic.
- Many respondents reported that lack of understanding is their biggest obstacle in cost management.
- A similar proportion admit that organisational politics hampers efforts to brin
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g costs under better control. - Close to one in five point the finger at unrealistic goals as being the biggest barrier.
- A third of respondents said that they would seek the advice of a specialist consultant when considering more strategic cost management.
“Cost reduction exercises” don’t work
However, it’s a sobering reality that, 95% of cost reductions achieved during the recession are expected to return in the short term. This equates to more than £90bn of costs across UK firms, says KPMG. In a literary review in 2009, the University of Salford stated: ‘An attempt to improve traditional cost management started in 1965… However, companies have been slow to implement new tools… There is broad agreement that current cost systems are not providing enough information.’
A clear difference in approach
COST REDUCTION
- Short term one-off project
- Focused on an isolated business cost or a single line in the ledger at a time
- Blunt instrument applied mechanically
- Undue weight given to headline price
- Adversarial approach to suppliers
- Well-intentioned but subject to “the knowledge gap”
STRATEGIC COST MANAGEMENT
- Long term and sustainable
- Holistic and dynamic process
- The “Total cost of ownership” informs decision-making
- Focus on value for money and impact on goals
- Suppliers seen as allies although independent
- Consultative or advisory – specialist tools, people, knowledge, experience are essential
Advance to profit improvement: with strategic cost management that is sustainable
Huge refinements in the science of effective cost management and have overcome many of the professional shortcomings of past years identified by the University.
Today’s strategic cost management programmes demand business systems and analytical tools to provide and maintain sustainable profit improvement. A Total Cost of Purchase® approach, for example, ensures that costs, once taken out, do not simply creep back in.
Whether you are a hard-pressed business owner, an FD wanting to build a culture of control and prudence, or an interim manager looking to maximise the impact of your first 100 days at your new assignment, for a cup of coffee and an exploratory chat on how to ensure you are building a sustainable platform for growth, contact the author:
Call Ron Yellon on 01234 865869.
Ron.yellon@auditel.co.uk | www.auditel.co.uk/ronyellon | @Ronconomics
