Aligning your costs and strategy by investing in differentiated areas and minimizing inefficient processes can help you transform your company
COVID-19 has left companies around the world in a period of huge upheaval and change. Countless businesses have tightened their margins, heightening their focus on costs, and many forward-thinking business leaders are now planning cost reduction initiatives so they can invest more in the business areas that need development and less in inefficient operations. But squeezing a few percentage points from slow and strained operations isn’t enough to uphold competitive relevance in disrupted marketplaces. Instead, companies need transformational strategies to reach their customers, accelerate their workflows, and improve their innovations.
Here, the divisional and group CFO Gary McGaghey explains the differences between the costs that can help your company and the costs that can hinder it and shares five steps to help you optimize your costs for the long-term.
Switching Up Your Cost Strategy
Delivering strategic change and laying the foundations for strengthened operational capabilities can be challenging. Many finance leaders have experienced the difficulties that come with implementing cost initiatives that fail to deliver long-term gains. These difficulties often stem from resistance from the wider company; such resistance can encourage boards to cut a small amount from each division, instead of considering where they could best deploy resources or streamline costs.
Gary McGaghey explains that instead of focusing on which costs to cut, companies can examine the resources they need to fuel growth and differentiation. For example, a company might opt for a digital transformation that sharpens the precision of pricing and risk selection while enabling them to deliver personalized, higher-level customer solutions at a lower cost. To achieve this, companies can refocus their resources away from low-returning business and towards higher-return opportunities.
Differentiating Between “Good” and “Bad” Costs
The key to a successful cost reduction plan is to target the resources that will give the company the best returns. Rather than cutting costs on the resources that drive profitable growth, you can cut costs from inefficient operations or non-essential areas of spending. Gary McGaghey notes that many companies can consider the following “good” and “bad” costs when rethinking their strategies.
Distribution can be unnecessarily cost-heavy, often because of poorly targeted marketing and low conversion rates (bad costs). But companies can adopt advanced analytics and sensor technologies to target customers, understand these customers’ needs, craft personalized solutions, and price risk in real-time (good costs). By improving conversion, companies can focus their sales and marketing investments to generate more favorable outcomes and ensure greater precision in risk selection. Meanwhile, personalized services can pave the way for justified higher prices and lower claims costs.
2. Transactional Processes
Financial services are often littered with wasted costs and low-value transactional processes (bad costs). This is because these processes typically require heavy manual work like inputting data into multiple systems. Instead, companies can adopt robotics and blockchain processes to automate and scale their processes, delivering savings that aren’t possible with outdated systems (good costs).
Many companies are spending far more than necessary on property, from flagship head offices to day-to-day offices for employees who must commute to sit at their set desks (bad costs). Instead, companies can invest in virtual working solutions and deploy collaboration tools so that teams can work remotely and hot-desk when they need to work in the office (good costs).
4. Service Providers
Outsourcing service providers has its benefits, but third-party spending often fails to generate value. Sometimes this comes down to poorly managed arrangements, and other times the lack of value comes from outsourcing an inefficient process without fixing its weaknesses first (bad costs). Instead, companies can re-strategise how they operate (perhaps by introducing automation technologies) and then engage the service providers they need (good costs). When the company generates the efficiency and then asks the service provider to drive this efficiency, they are much more likely to achieve the value they have in mind.
Five Steps to Optimize Costs for the Long-Term
Unfortunately, many companies struggle to maintain their cost reduction initiatives. However far they reduce costs, the returns still aren’t viable for some products (either because customers can find the products at a lower price elsewhere or because they don’t value the products). Often, the companies who face this difficulty aren’t focusing on value potential over cost or volume.
Gary McGaghey recommends that management teams follow these five steps to optimise costs for the long-term instead of simply cutting costs. This way, companies can rethink their strategies to uphold competitive relevance and maximize their potential without making unsustainable moves.
1. Craft a Strategy
Once you’ve drawn up a cost reduction strategy, ensure that you and everyone in the company has a solid understanding of this strategy, your operating model, and the risk-adjusted returns of this model. Consider the company’s current costs, the returns on these costs, and how viable these costs will be in five years when technologies, competitors, and customer expectations have evolved. You should also consider the interactions between business units or areas and the costs these interactions generate instead of using market-wide benchmarks to justify costs.
2. Align Your Costs With Your Strategy
Spend some time differentiating between the company’s strategic and critical costs and the company’s non-essential costs. Identify the capabilities that the company needs to achieve to reach customers and meet these customers’ needs. Then, compare the capabilities the company already has against the capabilities it needs. At this point, you should be able to identify the most important capabilities to invest in and the capabilities to minimize. Keep in mind that while you may be able to eliminate some costs altogether, you’ll only be able to reduce others (often in areas like property management, leases, and legacy system maintenance).
3. Think Creatively
Embrace technology, innovation, and creativity to optimize your cost base. Instead of looking at cost reduction in terms of percentage targets or benchmarks, explore all the possibilities for strategic growth. You might find opportunities across the value chain. Bold moves could include withdrawing from markets or streamlining product lines to focus your resources. When you cut back redundant operations, your company can thrive.
4. Lead Effectively
Set the direction of your cost optimization and deliver this as a business transformation initiative. Remember that achieving strategic cost reduction isn’t a part-time project. Much like any other strategically critical initiative, you’ll need to lead with direction and accountability. You’ll also need to secure senior management agreement and buy-in, ensure central governance, engage the workforce at all levels, and uphold collaboration and personal ownership between all team members.
5. Set the Culture of Cost Optimization
Having ensured that the culture of ownership is clear, you’ll need to frequently review your cost reduction priorities and update these. For example, your priorities might include instilling a culture of awareness and ongoing improvement and/or enabling period review. You can also incentivize staff to seek improvement opportunities so you can build a consistent culture of “good versus bad costs”.
Reap Financial Rewards
Gary McGaghey explains that following these steps can help you reap major top- and bottom-line rewards, differentiate your company, and provide the groundwork for the company to deliver on its objectives. Your company’s survival and success rely on your underlying cost base and competitive capabilities. So, target your investments precisely to maximize strategic advances and identify your low-performing processes to cut back on these operations.
The companies that are succeeding in their strategic cost reduction initiatives are taking their places at the forefront of the financial space. As the market sees new disruptions and continues to accelerate its pace of change, it’s these companies that will sustain a competitive advantage.
About Gary McGaghey
Finance professionals at all levels pick up insights from Gary McGaghey, an acclaimed CFO who has achieved major financial successes for a variety of private equity, privately owned, and listed companies. He is currently the CFO of the €1.3bn end-to-end marketing production and business services group Williams Lea Tag and the non-executive director of the children’s fitness analysis and testing provider Fitmedia UK.
Gary McGaghey is a chartered management account in the UK and a chartered accountant in South Africa. He holds a postgraduate Bachelor of Commerce degree with honors from the University of South Africa and a Bachelor of Commerce degree from the University of Natal. He has also completed the Financial Times’ Non-Director Executive Diploma.