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Beyond cost reduction

Companies need to look past cost cutting during times of crisis

by Rami Nazer

An economic crisis is too good an opportunity to waste. It is an ideal time to step off the treadmill and ponder improving your business, your core offering and your cost structure. This year could very well be the year when financially sound and forward-looking organizations actually make their fortunes.

Over the past 12 months, market conditions have been eventful for some and extremely difficult for many. Firms have been taking steps — preventive and remedial — to cope with the recession and emerge stronger. Their responses have been varied, as there is no universal or one-size-fits-all solution. Nonetheless, businesses must ensure that steps taken are both appropriate for their business models and sustainable in the long run.

Most sectors of the economy are vulnerable to the effects of the downturn, but our global research indicates that risks are even greater for sectors like banking and capital markets, real estate, biotechnology, asset management, telecoms, utilities, manufacturing, consumer products, automotive and media and entertainment.

To effectively address the economic downturn, enterprises must also remain adequately responsive to the expected upturn in growth and demand after the recession ends. They need to clearly understand the macroeconomic causes and the microeconomic means to manage profitability during these times while also planning to profit during the revival.

Opportunities in adversity
Ernst & Young’s recent report on corporate priorities titled ‘Opportunities in Adversity’ revealed that insightful enterprises focus on how to effectively reduce costs by acting on decisions that must be sustainable in the long term. This means reducing costs without compromising revenue streams, and reducing operational costs without burdening the business with heavy implementation costs. However, the central message of the study is that cost reduction has become essential, with more than 85 percent of over 300 top level executives polled citing it as a key issue for their business. Overwhelmingly, they have focused on four major areas: number of employees, information technology, employee benefits and real estate.

But is cost reduction the only initiative that corporations need to undertake? Is employee reduction the most effective in reducing costs? A pool of institutional knowledge is beginning to indicate the fallibility of most cost-reduction initiatives: that these are not sustainable in the long term.

While the first response to a more difficult market is to seek to improve efficiency by reducing costs, slowing recruitment and reducing inventory, the risk of reduced effectiveness is real. Cost cutting is frequently a short term solution.  The challenge is to ensure that the organization is robust enough to face new market conditions without weakening its business mission and to take advantage of opportunities that will undoubtedly emerge later.

Amongst cost reduction initiatives, two measures stand out from all others: business process improvement was cited by 77 percent of those surveyed, and supplier cost reduction was cited by 60 percent of respondents. At 47 percent, employee reduction came in after info-tech optimization (49 percent).

Managers need to understand the psychology of cost and treat sustainability as the key focus at the very outset, ingraining cost optimization behaviors in the organization while attempting to ‘take the pain of change’ out of the process.

While businesses evolve mechanisms to withstand an economic downturn, educative examples of what is really happening in businesses are already available, for example a global investment bank reengineered its product control and identified savings initiatives of $8 million, compared to an earlier target estimate of $5 million. A pharmaceutical manufacturing company strengthened an existing cost reduction program, conducted a ‘health-check’ and identified cost savings of between $45 million to $73 million per year from a total cost basis of $410 million. A global telephone company also implemented a new global purchasing organization to reduce annual costs by 22 percent on average.

Based on research and interviews with our clients, we have developed the ‘stress pendulum’ which focuses specifically on the issue of cash. The primary driver of management action is the amount of cash that the company has and is generating. If you are burning cash during a credit crisis, your priorities are clear. If you are generating cash through operations, the opportunities are many. In any case, the need for management action is paramount.

Rami Nazer, Partner, Ernst & Young Middle East

The authors of Executive Insights have been invited by this magazine to offer their professional opinions and analysis to you, the reader. Executive Magazine does not endorse the analysis of Insight authors, nor should the Insights be interpreted as reflecting the views or opinions of Executive or its editorial staff.

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