Mark Hixon is a Partner at global advisory firm Transform Performance International with over 25 years’ experience advising Fortune 500 companies on their cost management solutions. Here he provides Finance Monthly with 7 ways to manage costs and what considerations to make.
Not long ago, British Airways suffered a huge and unprecedented system failure. Flights were grounded, and the plans of thousands of passengers were at best disrupted and at worst ruined. The scenes at Heathrow and Gatwick were predictably chaotic, and there were suggestions that had the airline not outsourced its IT work, the incident might have been avoided. This, and other recent events, have brought the negative impacts of cost reduction to the fore once again–but it’s unfair.
Cost reduction, when done properly, merely serves as an improvement to a business. It should never be used as an excuse to defend process failures. Of course, there are times when organisations change their service standards and the impact needs to be understood, but these changes should never manifest as process failures. When this is the case, it almost certainly stems from failing to consider the consequences of not funding certain levels of service.
Many organisations embark upon cost reduction or cost management programmes but almost as many fail to deliver the required benefits. Some organisations even find themselves worse off. For nearly 20 years at Transform Performance International, we have worked with clients to improve their existing cost management programmes, and have a found a pattern of recurring errors, all of which can be prevented.
- Senior executives are not aligned to the requirements and only provide tacit support. Cost reduction is always popular when undertaken in other people’s business functions but less palatable when it’s done in your own area.
Solution: Use an analytical approach to set targets. In recent years there has been a great deal of intellectual debate as to how to set targets. We successfully developed an analytical approach to segmenting the cost base and setting targets based on activity classifications. This is a non-confrontational way of defining targets.
- There is weak sponsorship at the executive level. This is characterised by certain executive members or senior managers paying lip service to the programme and the targets but spending their time protecting their own areas of the business.
Solution: Each person on the leadership team should be set a target and these targets should be embedded into their objectives: ‘failure to hit the target = failure to achieve their bonus’. Businesses should also set end-to-end process targets that require collaboration.
- A ‘one-size-fits-all’ approach is used to make parts of a business take similar approaches to deliver savings. Most cost reduction programmes start with the premise that a consistent approach is required across all areas of the business, however some business areas are more suited to ‘process improvement’ type approaches whereas others require a service level driven approach.
Solution: Define a programme of work that considers how savings may be achieved within the various business areas and then apply the tools and techniques appropriate to each area.
- The scope and scale of change is not agreed at the executive level so improvement options are rejected or undermined. Cost management programmes often begin with good intentions but as soon as ideas are placed on the table for consideration they are knocked back.
Solution: Hold an executive workshop where a range of ideas are put forward and apply what you learn to frame the overall programme of work.
- The dynamics of the cost base are not understood.When targets are set, the real implications of the targets are often misunderstood. This is because the true dynamics of the cost base are not understood.
Solution Segment the cost base and analyse it to find out how much of it is addressable, how much is fixed and how much is variable. Fixed or variable analysis should provide data on how costs vary with volume as well as time.
- The root causes of cost are not addressed. When cost-saving ideas are put forward, there is often very little consideration as to what is drivingthe cost within a business.
Solution: Use an activity-based approach to collect data that enables the root causes of cost to be collected. By collecting the data in a structured manner you will be able to see how much of the cost base is affected by each specific root cause.
- The consequences of failing to fund a particular level of service are not well understood. Quite often, businesses suggest reducing levels of service but they do not analyse the risks of failing to support current levels of service. These risks can impact revenue, the ability of the business to maintain a going concern and potentially the end customer.
Solution: All ideas and suggestions should be assessed in terms of their impact on customer service and the overall risk they pose. Some cost management techniques, such as zero-based budgeting, have this type of risk assessment embedded within the methodology: i.e., every service level is characterised not only by the resource and cost requirement, but also in terms of the consequences of not funding it.