Better margins through strategic cost-cutting
5 MINS READ
Economic and geopolitical conditions worldwide are putting pressure on margins—a trend likely to continue for the foreseeable future.
Rising input costs, price inflation, and continued uncertainties in supply chains continue to put tremendous strain on traditional margin improvement programs.
Organizations that traditionally pursue arbitrary cost-cutting measures to manage margins are realizing that a defensive approach will not suffice. An arbitrary approach adds increased uncertainty to the fragile balance between growth, cost, and talent.
Typically, companies’ forecasted financial positions shape their cost-cutting programs, leading them to pursue a reactive and defensive approach. While this approach is sometimes required, enterprises need to be aware of the risks—most notably, the inability to sustain cost structure, which compromises the opportunity to build muscle and capabilities for uncertain times. As a result, companies that follow this path will continue to experience margin pressures.
This calls for a new approach to cost-cutting that makes it a strategic tool within margin management. What’s more: sustaining cost structure improvements will be imperative to maintain margins in an inflationary environment—especially for businesses with limited pricing power.
Figure 1: Approaches to optimize operating costs
To manage margins, companies must take a transformative and strategic approach to cost-cutting that encompasses both structural and operational levers.
This approach involves margin improvement programs that focus on building competitive advantage without negatively impacting growth, and that help companies maintain the fine balance between structural and operational levers with sustainability at the core, as shown in Figure 2.
Structural levers look not only at the current state but also beyond it, to better position the business for transformational opportunities. Operational levers aim to improve near-term efficiency, simplification, and liquidity, while focusing on building foundational capabilities.
While enterprises leverage structural and operational levers to reduce costs, they should be mindful that their actions don’t inhibit their ability to pursue growth and innovation.
Figure 2: Levers for strategic cost reduction
How to get started
Companies should kick-start the margin improvement program as a pilot to gain self-advocacy, focusing on learning and obtaining feedback from the pilot before scaling the program.
During the pilot, the margin improvement program should build foundational capabilities for spend visibility and governance. In the next stage, enterprises should scale to sustain the saving over the years, avoiding the fatigue of starting a new cost-cutting program each year. The margin improvement program should cover three stages:
Give attention to prioritized areas first and not the entire profit and loss (P&L) statement.
Select business unit (BU) or function with fewer spend levers.
Focus on foundational capabilities, adoption, and feedback.
Refine and scale across the business lines
Extend to both operational and structural levers.
Focus on monitoring and building core capabilities.
Continue process improvement and broadening scope.
Implement sustainable capabilities to align with the results.
Focus on strategic and industrialized capabilities
Figure 3: Stages in the margin improvement program
To realize greater value, companies need to combine the top-down and bottom-up approaches.
Traditionally, a top-down approach with benchmarks is used to size-the-prize. While this approach works at the executive level, it has failed to provide a meaningful answer on ‘how’ to find value.
We recommend a holistic blend of the top-down and bottom-up approaches. Here, the top-down synthesizes financial data to provide where and how the value is shifting. On the other hand, operational data provides bottom-up proof points on cost optimization opportunities with a strategic link to operation and technology capabilities.
Three areas that need to be considered in this combined approach are:
Value targeting: Set the ambition, provide insights and answers to these questions: A) Is my cost structure competitive enough to support future business? B) Where is value going and what are our peers doing to contain costs? C) How should we keep a balance of cost, talent, growth, and liquidity?
Value release: Identify the gaps in achieving the set ambition by performing a bottom-up analysis. Quantify prioritized savings with a clear action plan to realize the saving. Making simple process, policy, governance, and data changes helps realize value immediately.
Value sustaining: Design and implement new business capabilities of zero-based budgeting, control, and monitoring to maintain a sustainable level of cost structure. For sustaining value, the key is to define and measure success with financial, operational, or behavioral metrics.
Figure 4: Methodology for cost optimization
Instead of arbitrary cost reductions, companies should take a strategic approach, which opens direct and tangible opportunities for savings and value-enabled outperformance.
Successful margin improvement programs need to be viewed as a strategic priority or ‘fuel for growth’. It shows a clear path ahead that involves re-investment, incentivizing participants, and offering a meaningful process that measures success and creates accountability. While this inspires meaningful dialogue among executives, it also helps organizations to take advantage of uncertainty in markets and position themselves to thrive during different business cycles.