Maximising cost-cutting can fall well within the comfort zone of most companies

One of the most uncomfortable conversations that GCS has with companies in financial distress centres around cost management. If not managed appropriately, this is something that can easily become one of the most significant root causes of financial distress.

Cost-cutting is a fine balancing act. Companies need to be brutal when cutting costs; however, there is a difference between appropriately cutting costs and cutting costs to the extent that damage is caused to the company. A distressed company still needs to be able to trade itself back towards profitability.

How and where do companies begin this journey? I recently read an article on the Harvard Business Review website which provides closer insights into this.

Creating a Growth-Oriented, Cost-Effective Organization

The article points out that, to succeed at cost transformation, you need to start with a blank sheet and ignore sunk costs. This is the mindset underlying zero-based budgeting as well as Peter Drucker’s famous question “If you weren’t already in this business, would you enter it today?” Applying this lens to every project, line item, and role allows leaders to look at the cost structure strategically, which is imperative, because there may be no topic more strategic than where you spend your money.

But simply challenging every line item isn’t enough in our analysis—and on its own may feel like a disjointed and endless effort. We believe you also need to take five critical steps.

Connect costs to outcomes. The article adds that companies need to treat every Rand that is spent as an investment in creating the value that you give your customers and in the specific cross-functional capabilities needed to deliver that value. Costs should no longer be locked inside organizational silos that get protected and thus are disconnected from growth. Budgets must be discussed in depth with the leadership team and prioritized to focus on what truly supports your strategic goals and the capabilities that will help you achieve them.

A great example is IKEA. The company has long been guided by a succinct principle that makes this promise to customers: “We do our part. You do your part. Together we save money.” After opening his first retail store, in 1958, the company’s founder, Ingvar Kamprad (the I and K of IKEA), drove employees to pursue any cost-saving opportunity that didn’t affect the quality of the merchandise, the customer experience, or the efficiency of operations—a practice that continues to this day. IKEA’s designers, for instance, work continually on packaging to reduce its materials and size so that the company can fit more pieces into a container, save money, and offer lower prices. That congruence between strategy and execution is rare in product design. In many companies products are designed by people who aren’t responsible for managing expenses. But IKEA connects its design to all the outcomes for the customer, including cost. If you visit the company, its cost consciousness is apparent. For example, executives almost always take guests—even VIPs—to eat in IKEA cafeterias rather than fancy restaurants, to avoid any expense that might be passed on to customers.

Simplify radically. The article points out that companies often take their activities for granted and make incremental adjustments rather than take a bold, holistic look at what businesses, product lines, SKUs, or operations should be part of their future. Most also underestimate the cost of complexity, measuring only direct costs rather than system costs. One way to get a better perspective is to imagine a new competitor arriving in your segment without the burden of all your past decisions. How would it compete? What products, activities, solutions, and services would it create? How would it simplify the customer offering to create the highest value?

The Dutch company Philips had a storied history in, among other things, lighting and personal electronics, but in the mid-2010s, it decided to concentrate on health care and divest, spin off, or sell every other kind of business. Philips knew that to succeed, it needed to focus management’s attention solely on health care. With this tremendous simplification came new investments in the capabilities that supported a much bolder healthcare strategy—which led to major innovations in health products and services.

Reimagine value chains

Reimagine value chains digitally in rapid sprints. Yes, automation offers great potential—but not when it’s held hostage to big, drawn-out technology programs. Companies can realize the benefits of digitization by rethinking entire processes end to end, but they’ll capture much greater near-term gains when they put automation on top of—or in the place of—existing tools. To manage such efforts, some companies build “digital factories,” capability areas that are responsible for the rapid and continual rollout of automation across the entire organization. These “factories” dramatically streamline the process by following an established playbook. They also allow companies to evaluate all automation investments holistically. While you may question how you could afford one at a time of intense cost-reduction, focus, we have seen that they can not only pay for themselves but also generate enough savings to fund other cost and growth initiatives.

The article points out that when the executives at a global food and beverage company embarked on an enterprise resource planning (ERP) modernization program that was scheduled to last several years, they quickly realized that the cost improvements needed were so significant that the company couldn’t wait that long to realize them. They created a digital factory team that brought together people with experience in automation design, development, adoption, and maintenance and tasked them with reimagining manual, costly, and time-consuming processes (such as the procurement-to-accounts-payable cycle and HR practices from hiring through retirement). The team’s solutions captured savings within the current ERP platform while reshaping processes in preparation for the improved automation and insights the new system would enable.

Rethink what work you and your ecosystem take on. Creating powerful new capabilities isn’t cheap; a lot of technology, data, and people are involved. Smart companies recognize what has to be truly differentiated—and then think about who can deliver it best. Your ecosystem of partners probably has much greater scale in some areas than you have on your own. Outsourcing non-differentiating capabilities or even elements of your most important capabilities can allow you to focus your investment where it matters.

Increased complexity

What a company must do today is much more complex than it was just a decade ago. The traditional marketer, for instance, was a generalist who could manage a great variety of activities. But now marketing requires specialized expertise in many areas, such as social media, ethnographic research, data science, and content curation. Having all that know-how on staff is not only expensive but requires a talent model that accommodates career paths and skill development in a multitude of areas. Outside agencies can offer an easier way to access scale with such capabilities and often a more dynamic career track for specialized talent.

The article adds that, in the early 2000s, Apple realized that manufacturing was neither core to its strategy nor a historic strength. As a result, it rapidly moved nearly all manufacturing of components and finished products to its ecosystem partners. That freed the company up to pursue even greater innovation in materials and design and to further integrate data and devices across its various offerings, strengthening its overall product differentiation.

Build a sustaining, cost-focused management system. Smart companies don’t think of cost-cutting as a one-time reaction to a slowing economy; they believe it’s a primary duty of managers to remain constantly vigilant about costs. But that attitude is unusual. Too many companies downsize during periods of economic stress, only to turn around and increase selling, general, and administrative expenses in subsequent years—without seeming to understand this pattern.

Budgets are a real test of how your company thinks about costs. If yours tend to get adjusted incrementally through function-by-function agendas, you’re probably not actively—or strategically—managing them. But if your budgets are zero-based and allocated and evaluated across functions, focusing on the most critical and differentiated capabilities, you’re creating a culture and a process for managing cost.

Timing evasive action

The article points out that HP took the right approach in 2019. Although the global economy was strong at the time, the iconic provider of computer and printer products and services had begun feeling headwinds from increased competition and commoditization.

In response, it embarked on a cost transformation that radically simplified its product portfolio, eliminated an entire organization layer to get closer to customers, and centralized R&D. HP optimized its real estate footprint, creating more-efficient digital workspaces as it moved to a hybrid work model. It also built a new digital backbone: an ERP system that allowed it to deploy additional tools and capabilities. Those carefully considered moves cut more than $1.3 billion in annual costs. Those savings enabled HP to make important investments in both R&D and acquisitions that positioned the company to weather significant volatility in its sector.

HP is now aiming to achieve $1.4 billion more in annual savings by reducing complexity and costs in its mature businesses and simplifying its operating model. A substantial portion of that money will be reinvested in its Future Ready initiatives, which seek to drive growth through innovation. HP’s chief financial officer, Marie Myers, notes that these changes often require “hard choices” but believes they will allow the company to keep delivering cutting-edge offerings to its customers.

Comfortable interventions

The role of business rescue practitioners or turnaround professionals will be key when it comes to managing this journey.

In my experience, companies can comfortably reduce their costs by 20% and remain effective. A 20% reduction in costs will significantly aid a company on its journey towards addressing its financial distress. From here, it is about redirecting funds in a way that will best suit a company and its future ambitions.

Phahlani Mkhombo is the MD of Genesis Corporate Solutions and is a Senior Business Rescue Practitioner.