Managing Costs is not about cutting discretionary cost lines such as marketing budget, staff training budget or for that matter entertainment or staff welfare budgets. These are short sighted measures; yet sadly, many organizations resort to these measures. Contrary to being helpful, cutting marketing or staff training budgets may be detrimental to the organization's interest in the long-run by indirectly curbing the growth engines of the business or de-motivating the employees.
Besides, cutting down discretionary lines does not change the basic cost structure prevalent in the organization and therefore does not result in cost reduction in the true sense. Any initiative to reduce cost that does not yield recurring benefits to the Profit & Loss Account should not qualify as a cost reduction initiative. It is merely a tactical measure to meet the Profit & Loss Account target for a given year, which is, as I mentioned, a myopic measure.
Cost Management or Cost Control is about creating lasting 'value' to the shareholders in the long run by becoming more productive and efficient, and by bringing about a positive change in the way we do things, as an organization.
To embark on a Cost Control exercise in an organization, it takes a lot of courage on the part of the business head. First, one needs to commit to a cost reduction target, not knowing where the reduction is going to come from and secondly & importantly, convince the whole organization towards working on it.
So then, how does one go about it?
The first key point to understand is that Cost Management is not the destination to get to, but a journey to undertake. Cost Management is not a onetime exercise; rather it is a discipline to inculcate at every level.
Broadly speaking, there are three steps to Managing Costs well:
- Revisiting fundamental internal processes towards becoming more productive.
- Understanding where the bulk of the costs lie, with an objective to aligning costs with the revenue objective &
- Creating a Cost Culture within the organization
Why do we do things the way we do them?
Internal processes determine the pace and integrity of various activities within an organization, leading up to customer interface. Questioning Status Quo and reviewing the processes end-to-end, with an objective of understanding where the improvement areas are, is a key step in moving towards a highly productive environment.
'Speed-to-Market' is a critical ingredient of maintaining a competitive edge and it applies to every process in the organization, since they all, eventually, impact the customer. Turnaround time of activities also has a bearing on resource productivity and therefore on cost. By reviewing and improving the efficiency of each of the processes, it is possible to achieve cost saves over a period of time.
Example: if the process of application verification is simplified to reduce the cycle time from say 50 applications per person a day to 75 applications per person a day, that is a 50% efficiency improvement, which could result in man power cost saves. Assume the per person cost is 100$ a day; Over a 20 day month, this translates to $2000 to process 1000 applications. If the efficiency were to improve to 75 applications a day, then, for processing 1000 applications, it will only take 13 days, which means a cost of $1300, a save of ($2000 - $1300) = $700.
This is just with regards to one process. By conducting a review of all key processes over time, the organization will immensely benefit on an overall basis.
It is also important to set productivity benchmarks or targets for each of the process intense units with repetitive processes within the organization.
For instance, how many customer calls are being answered & resolved by the call centre in an hour or how many outbound calls are being made by the telemarketing unit, how many walk-in branch customers are being handled by the tellers or how many home loan applications are being processed in an hour are all important questions to find the right answers to, so as to set the right benchmarks or targets. Benchmarks can be progressively stretched over time, depending upon where the organization stands currently. Industry benchmarks would also be useful to understand how far or how close the organization is from it.
Benchmarks or Targets should help drive improved individual and group performance. These should also become the basis for resources planning for future.
Understanding Costs & Aligning to Revenue
What value is each element of cost creating?
At a basic level, it is important to understand where the bulk of the costs lie. How well do you know your Cost Base is an important question to answer before you could attempt to influence it. Professor Agassiz once made the following comment to his student, about a fish in a laboratory, which aptly applies to an organization's cost challenge:
“Look at your Fish. The more you look at it, the more you will realize, there is new information about its structure, fins etc. that you did not know before”
In other words, the more an organization analyzes its cost base, the more understanding it would gain about it, which in turn would help it in managing its own costs better.
The following steps are worth considering in this effort:
- Setting up a dedicated 'Costs Management' team to focus on the cost challenge of the organization, with representations from all departments and the CFO's office leading it, is a good first step in dealing with the cost challenge. Cost Management is not a one-time exercise. It needs to be an ongoing exercise and it helps to create a cross functional team to manage it continuously. The team, lead by the CFO or his representative, could conduct on-going discussions on the key cost challenges facing the business and present findings during the monthly performance discussions with the CEO or Business Heads. If an organization is made up of many businesses, then such a team may be set up for each business, depending upon the scale and complexity.
- Establishing a robust monthly Cost Report with details of the key cost lines and the underlying drivers tracked at a business unit level is imperative in an organization's cost management journey. It is the CFO's responsibility to make sure that such a monthly report is provided to the Business Heads. Key requisite here is not to overload the business heads with data, but to provide timely & relevant information about the major cost lines & their underlying drivers so as to enable a thorough understanding of the cost base. The CFO can then help the business head(s) clearly understand as to which underlying levers need to be worked upon, to favorably influence the costs.
- Understanding the Efficacy of Cost incurred: If the CFO can articulate how much every dollar spent by business is translating into revenue, it would be clear to the business head on whether or not it was worthwhile.
Establishing a Cost Control Culture
How does one rally the entire organization?
To embed a Cost-conscious culture within an organization takes time, especially if the organization has been run differently in the past. It needs a lot of communication and articulation. Leaders of the organization have to take responsibility to educate the masses about the need to embark on this journey. They have to take the onus upon themselves to educate employees about the financials of the company over a period of time, how they are expected to change going forward and why there is a need to inculcate cost discipline in every area. Mini-targets at various levels will have to be set and linked to rewards or incentive schemes. Leaders have to find innovative ways of dealing with the negative energy that it can create across the organization. Some organizations have successfully installed the practice of inviting cost reduction ideas bottoms up by rewarding the 'idea of the month' and publishing it in the monthly newsletter. This is one way of creating a healthy atmosphere and engaging every one. Recognition by the CEO could be another motivator to get the employees thinking in the right direction.
In Part II of this Cost Management article, we will look at how effectively we could classify an organization's costs with a view to isolating non-productive costs and how the organization should approach setting clear-cut action plans for cost control. We will also look at why new organizations have a distinct starting point advantage via-a-vis established business when it comes to cost leverage.
Keep a look out in this space. Meanwhile, please feel to send in your comments and feedback by posting your comments below or by direct mail to Ramesh.email@example.com