Do we Really Need Strategy For Cost Optimisation or Cost Reduction?

Lockdown has been extended for another two weeks. Even after opening of lockdown I presume personally, market will face difficulties in cutting any kind of cost or cost optimisation. All Business strategies will have to undergo complete transformation. Disruption in supply chain, employee productivity, absenteeism, Cash Credit problem, Demand functionality, Raw Material availability at right price will be big issues in coming time.

Entrepreneurs for few weeks will not be able to understand in which direction business has to be taken. People will do routine activities like closing of books of account, will talk to customers and suppliers and try and understand the situation.

However one thing is certain, strategy in most case will be “cut head count, cut travel, cut training, cut overheads”. However, cost reduction plan may not always be right approach for businesses.

In almost any nature of company, Revenue = Direct Material cost (40-60%) + Labour Cost inc. Salary (10-30%) + Factory/Mfg Overhead(5 to 8%) + Finance Costs (10-15%) + Admin Overhead inc. Selling Costs (3 to 5%) + Profit (Accordingly).

As companies gear up for large-scale cost-cutting measures, they are struggling to identify the most effective means of doing so. Therefore, organizations will have to focusing cost optimization efforts by limiting service offerings or reducing the product portfolio.

A Chinese general Sun Tzu, The Art of War, likens a strategy to river. Strategy follows one clear direction to achieve long term goals. Many executives presume strategy is not required in managing costs. However, majority of them grew up in days of negotiation not knowing how to deal with this pandemic strategically. But Fundamentals of business are going to remain same delighting customers with leading technology, quality and excellent service , all this at lower cost than the competing supply chain.

So How to Manage cost effectively in short term and long term without hurting business morales and survival. Here are some of the points for consideration.

Short Term Recommendations

If you have to take immediate action on costs — even if you haven’t had time to fully formulate a strategic cost approach— you can help to avoid rash decisions.

1. Target immediate impact. Eliminate, reduce or suspend items that will have an impact in one, six or even nine months, not in years. Examples include expenses incurred and paid monthly, quarterly or on a “pay as you go” basis, rather than annually.
2. Reduce, don’t freeze. Focus on costs that can truly be reduced or eliminated from the cost base, not just frozen out for the current period only to reappear again in few months of financial year.
3. Treat cash as king. Target line items that will have a real cash impact, such as real operating expenses like service costs. Make budgeted cash flows to understand position of company as compared to peers.
4. Plan to do it once. Few organizations cut deeply enough the first time, so they then need to revisit cost cuts — creating a destructive and unproductive cycle of uncertainty, effort and lost productivity. Cut or reduce “hard” enough the first time, and only do it once, especially in workforce decisions where cycles of ongoing reductions can be particularly destructive.
5. Tackle both variable and fixed costs. Variable cost if reduced in any manner through alternative raw materials, change in procurement policy, improvement in production process will help companies far better.

Long Term Recommendations

1. AIM and Drive: Understand your cost and value baseline. Establish your current spend and efficiency. Benchmark your spend and efficiency against peers to identify target areas for improvement, depending on enterprise goals. For example setting the target of reducing labour overheads, may result in production disorientation which may hurt overall company goals. Converting Fixed salary structure to variable cost structure through incentive plans may be one of the strategies.

2. Identifying Critical Costs in the Organisation: Identify and prioritize opportunities.Assess the likely impact and potential downside of all cost measures in scope to ensure the best fit. Make sure to identify and prioritize initiatives that best support your objectives.

3. Define and Measuring the Key Cost Drivers For example defining & Measuring Procurement Costs, Logistics cost, Repair and maintenance per unit of cost of production will help in avoiding wastages and losses. Reduce & Eliminating the cause of Costs.   

4. Implementing the Action Review the strategy determined with all the key members of the organisation for smooth execution sticking to overall business goals.

5. Verifying the Plan again with Cost Monitors  Try and monitor the situation with Benchmarking cost as determined. Variable cost and fixed cost constitute cost price of the product. It is advisable to reduce variable cost in long term which will help in competing with other players advantageously.

Conclusion:

Uncertainty is the new normal, so its imperative that finance leaders carefully weigh the implications of frantic cost cutting vs. thought full cost optimisation. Every cost head has to be reduced strategically then only companies will be in better position to survive rather than just overheads. Don’t Forget Human Resource Transformation and Leadership Traits will play key role for companies to survive and rise again.