The cost boomerang

IT IS NO surprise that corporate costs are roaring back into the business. It wasn’t that long ago that CFOs and finance directors were single-mindedly slashing costs in an all-out effort to withstand the financial crisis and survive the ensuing recession. And now, as many of the world’s economies start to flounder under the weight of sovereign debts, and with an uncertain economic outlook, companies need to focus once again on cost-management efforts as a way to survive a protracted and slow recovery.

But there are lessons to be learned from the recession. Rather than knee-jerk cost cuts, organisations need to embed sustainable cost efficiency and turn their recession-induced diet into a lifestyle change. Most finance directors will have found that many costs taken out during the recession have already starting to flood back into the business at an incredible pace.

In fact, according to a KPMG survey of UK and European finance leaders, more than 95% of cost reductions that were delivered during the recession are expected to return in the short term – this equates to more than £90bn of costs across UK firms.

Cost as a competitive advantage
Taking a closer look at the figures, one quickly realises that not all companies are seeing costs increase at the same pace. For a few organisations across Europe, the recessionary fuelled cost-cutting exercises of the past three years have offered a valuable opportunity to identify and execute cost efficiencies that are proving resilient in the face of growth. And today, these organisations are starting to see the fruits of that labour: higher margins, more flexible working capital and – ultimately – greater competitive advantage.

The sharp side of the boomerang
So why are recent cost-cutting measures proving to be so unsustainable for others? Our research finds there are two distinct factors driving the return of cost. For one, the majority of cost reduction measures in the past were conducted in a knee-jerk fashion, often focused on chasing short-term benefits without due consideration for the long-term sustainability of those actions.

As a case in point, respondents to KPMG’s survey across Europe were twice as likely to have reduced service levels during the recession than discontinue unprofitable lines of business, which would arguably have provided longer-term and more sustainable cost savings.

The cost boomerang is also being propelled by a lack of formal cost controls in many businesses, particularly during times of growth. In fact, given the briefest glimmer of hope, company focus on cost seems to diminish rapidly. Almost three in 10 UK finance managers voiced concerns that their company was relaxing cost controls too early in the economic cycle; almost half lamented that cost controls had not been sufficiently embedded into their organisation’s culture and working processes.

Aligning the cost base to future strategy
The most significant concern for UK firms is the rising cost of finance, which was cited by nearly 80% of respondents. But salary inflation (78%) and increasing headcount (70%) are also threatening to eliminate bottom-line savings.

Organisations will need to redouble their cost-management efforts to make sure that returning costs are invested into the parts of the business that deliver the most value and achieve the highest margins.

However, it is also clear from our report that many European organisations are aware their cost base is not aligned to their future strategy. In the UK, more than 85% of respondents admitted they planned on significantly changing their cost base to align with their company’s future growth strategy. At the same time, less than half of UK respondents felt their finance community received accurate and timely cost information at an appropriate level of detail to make these critical decisions.

Understand the cost of costs
But the return of cost is not a foregone conclusion. Indeed, sustainable cost efficiency will soon become an area of competitive advantage that will be keenly fought over by executives around the world. For many FDs, this process will – by necessity – begin with a careful analysis of the existing cost drivers of the organisation to understand where value is created.

This will require a new way of thinking about the business that challenges the accepted business models to ensure that decision-making is driven by profitability, return on investment and quality of earnings. If not, businesses will be limited in the scope they have to make substantive changes in areas that could deliver real cost efficiency, such as their operating models, geographic footprint or product mix.

Businesses that are able to identify and exploit sustainable cost efficiencies will almost certainly enjoy significant competitive advantages over their peers, better profit margins, more flexible working capital and a greater alignment for future growth.

But those that aren’t seem destined to remain at the mercy of the economy, doomed to replay a cycle of market-driven cost-reduction and reactive, knee-jerk survival strategies.

Here are five recommendations for driving cost efficiency in the post-recession business environment:

1. Maintain board-level focus on cost management as a strategic priority.
2. Examine the business from the point of view of an external investor.
3. Create cost and profit transparency to ensure you understand where profit is generated.
4. Engage front-line workers in a culture of cost consciousness.
5. Equip staff with the proper tools and support to ‘walk the walk’ on cost efficiency.

Martin Scott, partner and head of operational strategy, KPMG