Now that the economic climate is getting milder, many finance leaders are moving away from bolting down expenditure and are instead seeking investments to support growth or finally releasing funds for deferred projects. But the market is still fragile and it is unclear as to whether trading volumes and margins will return to the levels seen before the financial crisis of 2007-8. Few organisations can afford to leave their fixed and indirect costs at their current levels, so it is time for CFOs to lead the challenge and focus on these costs. So what is the best approach?
The traditional method is cost reduction, typically featuring budget haircuts of 10% across the board. It is a valid approach to cash conservation in an emergency, but it often fails in the long term because it breaks processes- and repairs to ensure continuity of service often cost more than the original saving. Some people hope that re-structuring the organisational will save the day but this process is extremely complex and often disengages the workforce. It also fails to address operational economics.
In contrast with cost reduction, which is seen as a project with a finite lifespan, cost transformation has no endgame. This approach not only tackles any immediate problems but also considers the organisation’s identity as a whole. It is a sustainable approach that encourages everyone in the organisation to focus on what adds value and to challenge the wasting of resources, wherever this may be happening.
For cost transformation to work, a CFO must mobilise the workforce by defining affordability targets and charging everyone to hit them. The leadership team needs to be convinced that the targets are achievable and in line with corporate objectives. Audi’s targets will not be the same as Skoda’s, for instance, as customer value differs. Affordability must align with the business and the market. Cost transformation promotes the view that if one area is augmented, another must be cut by an equal amount.
The CFO needs to start the process as a sponsor, rallying the senior managers. There must be consistency in their approach to cost transformation, as any differences in the managers’ priorities in this area will be noticed and may end up hindering progress.
Once targets have been allocated to each function, the organisation works through the cost model. Every element is examined for affordability and represented in a graphical format that everyone can understand. Shadow functions come under scrutiny. Where the movement of work between functions causes delay, put the two together to streamline the process.
Most of these concepts are basic, ensuring that simple things are done well. But simple does not mean easy.
Not everyone will be ready for the journey – and it is the CFO’s responsibility to overcome resistance to change. Stakeholders in the transformation can be categorised into the following groups:
- The Leader: The CFO as sponsor, supported by the CEO and HR Director.
- The Followers: managers and staff.
- The Victims: employees who struggle with change initially but can be supported through it to become followers.
- Game Players: Those who oppose the transformation. They quickly identify opportunities where they can outrun the change and are prepared to fight dirty when the stakes are high.
Creating the right environment for cost transformation entails aligning the thousands of actions taken in the organisation every day to a common intent and co-ordinating people so that they work together rather than tripping over each other. Effective management and coordination are the result of thorough planning and diligent execution.
The desired outcomes are as follows:
- Clarity of accountability for expenditure in every individual’s mind.
- A situation whereby sacrificing something that is dear to you or your team for the good of the business is appreciated by the rest of the organisation.
- Urgency – the elimination of waste is a continual process.
- Persistence – one good act is the start, not the end.
- Resilience – there are likely to be many challenges and confrontations.
Fortunately, there is good experience to guide the making of such a change. A skilled team is necessary to support and guide the development of this environment. It will draw on business transformation, enterprise architecture and other techniques. It will translate the management-speak into actions that have a clear contribution to the desired end-state. This allows simple, actionable instructions to be delivered.
Adjusting the organisation’s recognition and reward systems to encourage the desired behaviour is a vital element in achieving such an environment, so it is clear that effective cost transformation requires a lot of planning. This is not easy and tempts many who attempt it to take disastrous shortcuts.
We suggest the following three techniques to help you deliver a sustainable cost transformation:
- Affordability – in which every element that contributes to cost is examined. If you were to invest in something new, what would you need to give up in order to avoid breaking your affordability target? Budget holders should ask themselves 5 questions here:
- Can we stop doing this?
- Can we use a cheaper option?
- Would the business willing to pay for it?
- Would the business have the capacity to deliver this?
- Could I make the process run more efficiently?
- Fifty Percent Based Budgeting (a variation of Zero Based Budgeting). Ask managers to re-assess all discretionary spend for affordability. Manage the budget as an investment portfolio so that all elements are aligned to the business’s chosen direction and are balanced overall.
- Establish ‘Internal Currencies’ reinforced by Simple Actions. Define an imperative to act that is credible and clear to everyone. This makes it easy for people to test the alignment of decisions with the target. If someone makes a request to expand their team at an incremental cost of £5m a year, is the investment likely to deliver more than the 4000 new customers required? Simple actions support internal currencies by acting as a cultural drumbeat that reinforces the values – e.g. “Treat every £1 of the company’s money as if it were your own”
The simple action of applying a cut across the board is well intentioned but is seldom sustainable. To lead a real change takes far more effort. In order to make cost transformation affordable and sustainable, CFOs must show real leadership. Beware of leaders that will not challenge the wasting of resources. If we do not do it for ourselves, the competition will cut us without mercy.
William Hooper – Oareborough Consulting
Jason Box – Cost Transformation Ltd.
Jason Box is a leading cost transformation expert who has delivered multi-million pound savings for organisations spanning several industry sectors. Jason is the CEO and founder of Cost Transformation Limited, a specialist consultancy advising and delivering cost transformation.
This article was first published in the April 2014 issue of Financial Management Magazine, and is reproduced here with permission.