Four years ago, the refining industry was in the midst of economic turmoil. Demand for refined products had fallen during the recession. Refining margins – the difference between the value of a refinery’s finished products and the cost of the crude oil, labour and facilities used to produce those products – had tightened.
To strengthen its competitive position, Irving Oil set a big goal: Cut $100 million in operating costs by 2014, starting with the 2011 budget.
It would be a challenge. Irving, a private energy company that refines fuel such as gasoline, diesel, and heating oil mainly for retail and wholesale markets in the north-eastern United States and Canada, wanted the cost reductions to be sustainable. So the company enlisted the help of executive coaches to instill principles in activity-based costing and to guide budget managers through a process that would help them find a way to understand cost drivers and remove excess costs from their departments.
“What we wanted to do was not just make it about the annual budget cycle,” said Joseph Reny, CPA, CGMA (at left), the director of supply management at Irving Oil. “We wanted to make it a learning exercise, too. And the rationale for that was that if we properly trained our managers and our budget holders [on] what drove cost and how we might be able to maximise their return with lower cost, we would have a better chance of the whole activity sticking and actually achieving a fairly significant production goal.”
In addition to the $100 million goal, the challenges for Irving were to carry out the initiative with minimal disruption to managers’ jobs while driving home the importance of middle management’s role in sustained cost reduction.
Some managers became defensive when told about the basics of activity-based costing. “We can’t really break it down that way,” some said, according to Reny. “It’s too difficult.”
Once they were trained to apply costs to individual activities, they began to find ways to be more efficient.
An example that illustrated the change at Irving: Managers, some possessing a lack of understanding about the company’s Oracle financial system, made their lives easier by entering numerous transactions as “miscellaneous,” which contributed to nearly 1,000 account reconciliations per month. Some of these non-value-adding reconciliations took 15 minutes; others could take two days.
“This was one of the easier projects to realise an immediate benefit,” Reny said. “The first thing we did when we discovered the large number of reconciliations was converting to a cycle process.
“Instead of doing 1,000 a month, we switched to doing 500 per month, allowing us to cover all reconciliations every two months. Once that process was stable, we expanded to a three-month cycle. This allowed us to cut the number of monthly reconciliations from 1,000 to 350 without any material loss in benefits. The more difficult piece of the transition was stopping the use of both miscellaneous expense accounts and the use of the word ‘miscellaneous’ in journal entry descriptions. We found that using the proper expense classification and providing a simple description with journal entries made a huge difference in the time it took to properly complete a reconciliation.”
Reny says four themes were critical in carrying out the expense reduction plan. They’re tips that can be applied to other businesses:
Set a big goal: Reny said that the goal of $100 million would get the budget managers’ attention. “We knew that if we didn’t make the goal very large and difficult to attain, it wouldn’t be taken seriously,” he said.
Executive buy-in: Irving’s executive team at the time was on board from the outset, Reny said. They helped lay out the vision and scope of the project to employees and made it clear that the initiative was not optional. “We knew that if you don’t have buy-in from the top, activities like this generally don’t get off the ground and go very far,” he said.
Seek an outside opinion: Plenty of organisations specialise in business coaching. Irving had a long-standing relationship with Babson College Executive Education, which provided executive coaching to Irving’s managers. “They bring an expertise in education that most companies don’t have,” Reny said. He said that Babson professors not only designed the programme with education and execution in mind but also taught the concepts and coached the managers along the way.
Communication is critical: The company arranged for teleconferences that were designed to answer questions and pass on best practices. Those calls were recorded and archived so that people who missed them or simply wanted to review could listen. “That was the chance for participants to call in and say, ‘Well, here’s where I am, and here are the questions I have,’ ” Reny said. “And then others were able to hear what progress was being made.”
Irving’s change in costs and culture
The company continues to work towards achieving the $100 million in cost savings and was more than halfway there through December 31st 2012. “That’s excellent progress, and we have two years remaining to achieve the original goal,” Reny said.
And, perhaps more important, the exercise changed the mind-set at Irving. Many managers could talk about lean methodologies and activity-based costing, and they also became more collaborative.
Related CGMA Magazine content:
“Boot the Budget? Why Rolling Forecasts Might Make More Sense”: Traditional budgeting practices are keeping finance departments from remaining relevant in their companies, consultant Steve Player, CPA, CGMA, says.
“Five Critical Factors in the Design of a Strategic Plan”: Strategic planning can’t happen if a company is leadership-deficient, says executive coach Larry Bienati. This article focuses on five critical success factors in the design, accountability and execution of a strategic plan.
“Companies Still Tightening Belts Despite Return to Growth”: Although companies are reporting growth in much higher numbers, cutting costs remains a part of their business strategy for the next year and beyond, according to a survey of large US companies.
—Neil Amato (email@example.com) is a CGMA Magazine senior editor.