As companies discover new levels of uncertainty and pessimism, there is one item on every CEO’s agenda. Cutting costs. Some of them do not have an option – there is simply no cash to incur costs and there is no credit available. Are the rest of the companies being smart about cutting costs?

It is common to see companies sack low level staff, executives from the staff functions, contract workers or switch off air-conditioners. They certainly help but one would argue there is far more significant level of costs that can be removed. And in the process of removing costs, are companies looking at fundamentally changing the ways in which they compete for the better?

The obviously wasteful elements of costs have to go – there is no question. Other than these, it will be useful to consider the following aspects while cutting costs.

• Life cycle of costs
• Supply chain costs
• Structural costs

Life cycle of costs. The downturn offers companies the unique opportunity to hammer costs down over a three – five year time frame. When everything is cheaper, it is a great time to renegotiate contracts for services, media, hotels, transport, etc. It is cheaper to buy air time now and communicate with the target audience – it was always expensive to get prime time TV or banners on popular websites or the right size/page in a national business paper. Brand building is less expensive today.

It is possible to shift to the best locations for retailing today with a 6 -9 year lock-in of lease. There is furnished space going cheap. Good talent that was hard to get is available. It is easy to go to top university campuses without the fear of having to pay high entry salaries. There are experienced people who were difficult to get and more difficult to retain are available.

Acquiring market share is easy for a relatively strong company. There are a number of small players exiting the market – being present in the market and having visibility means sales growth. In fact, there are a number of companies that have seen growth in the bad market.

Therefore, the time horizon that a company considers to manage costs will determine the way in which it responds to the crisis. It can be completely short term and defensive or it can significantly enhance the competitiveness of the enterprise over a period of time.

Supply chain costs. As was mentioned earlier, it is common to see companies going after overhead costs. All the overheads would add up to about 20% at the best for manufacturing companies. Therefore, the total pool available for reduction is rather limited.

In contrast, the material cost of 50-70% of sales is still a far bigger opportunity. It is common to find mismatches between market demand and what is manufactured leading to piling of stock and under-utilization of capacity. If the supply chain processes are well aligned with a pull-based system and one is able to achieve a 30-45 day reduction in inventory and a 5 - 10% increase in productivity, one can potentially achieve far more than what can be achieved by looking at just overheads. This would mean release of cash quickly, leaner/flexible supply chain better prepared for the uncertain times and minimizing the risk of commodity or currency fluctuations. Companies are finding there is tremendous amount of opportunity in their supply chains as they start looking at them closely.

Structural costs. These really keep the CEOs up at night. Beyond a point, they are the hardest to crack. And sometimes represent the biggest opportunity. Structural costs can be dealt with in two ways – one reduce them to the extent one can and two, see how much of the fixed structural costs can be made variable. Out-sourcing of processes from the developed markets to India is a good example of reducing structural costs. Moving offices from down-town locations to the outskirts has been something companies have done and are doing.

There are cases of companies pushing assembly of components sourced from multiple vendors to the larger ancillary units to make the costs variable. There have been cases where manufacturing companies are moving some of the finishing processes closer to the market thereby achieving transporting bulk material than packed items – by staying closer to the market they buffer less stocks. Globally, companies are looking at strategic sourcing rather than manufacturing in their own premises or at the JVs.

More dramatically, global companies are dismantling engineering/R & D and distributing such work amongst service providers. They are completely out-sourcing manufacturing where the product life cycles are short and there is uncertainty in the marketplace.

As Tom Peters said in a book he wrote, you cannot shrink your way to greatness. Taking this slightly out of context, cutting costs is not the primary purpose of an enterprise. Therefore, under most circumstances, the thin like that divides cost cutting and disabling the company from performing in the future should never be crossed. With so much of preoccupation with the gloom that surrounds us, we often overlook the fact that when the turn-around happens, it can be dramatic and will throw up a number of opportunities. So the cutting of costs should be limited to the fat and not the muscle or bone.

For the purposes of deciding where to start, a typical cost optimization model is presented below. This sets out the typical focus areas of companies at different points of time. While this is a useful guide, a company will have to set up a cost agenda that will best work in its competitive environment.

Article written by
Mr. Kumar Kandaswami,
Senior Director, Deloitte

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