Instead of acting hastily, think strategically about cost-cutting

If you can keep your head while all about you are losing theirs, you’ll be an effective management accountant.

Amidst the economic turmoil caused by the coronavirus pandemic, many finance leaders and professionals face intense pressure to cut costs hastily. Such stress can lead to mistakes that damage longer-term growth prospects, business relationships, and staff morale.

Companies have already fallen into the trap of rushing cost cuts in the latest downturn, said Paul Gardner, ACMA, CGMA, the CEO and CFO of Fresh Accounting, based in Hong Kong and Singapore.

“Countries closed borders quickly when the COVID pandemic started,” he said. “CFOs have had to react very quickly and are still under immense pressure. In that situation, cutting costs can become emotional. But we have to avoid emotion by reviewing each cost forensically — for example, around whether it helps retain customers and minimises lost sales.”

Finance professionals have little time to get this right. During a recession, the average time before companies need a material reduction in overheads is nine months, according to Gartner. Given the severity of the current crisis, finance leaders may be under pressure to cut even faster and deeper.

A recent survey by Gartner showed 55% of business leaders expect cost decreases to continue, and just 16% expect cost pressures to abate over the next 12 months. A quarter of these companies take a uniform, across-the-board approach to cost-cutting, which can result in valuable costs being slashed. Gartner also said rushed cost-cutting is a major cause of strategic errors during a downturn.

“Easier to remove” does not necessarily mean “less valuable”. Factors such as headcount and expansion projects are critical to success, so cutting costs hastily can undermine a company’s hard-won growth and efficiency.

Who locked the stationery cupboard?

In tough times, one common corporate reaction is immediately cutting expenses on small items such as office supplies.

“Every company I’ve worked for under cost pressure locked the stationery cupboard,” said Mark Gault, ACMA, CGMA, of UK consultancy Gault & Co. “This symbolised their knee-jerk approach, which included cancelling important projects. But businesses need investment to keep growing.”

Well-conceived, well-managed projects are the lifeblood and future of a company, Gault said, yet they are often the first thing to be cut.

“For example, we’ve seen banks drastically cutting projects that replace outdated technology systems. These systems restrict their ability to respond to the wave of new fintech entrants, so will have long-term implications.

“Another typical short-term reaction is to freeze recruitment and renewal of temporary staff,” Gault said. “This can also harm long-term prospects as it removes the specialist skills companies need to deliver projects.”

Companies that can simplify operations give themselves “breathing space to make considered assessments of projects, retaining those that deliver cashable benefits quickly or secure long-term strategy — and pausing those that do not”, Gault said. “This avoids the debilitating impact of knee-jerk reactions such as freezing recruitment, procurement restrictions, and, in some cases, top-slicing functional teams across the business.”

Dubai-based Anju De Alwis, FCMA, CGMA, managing director at training company Ultimate Access, said potential loss of talent due to untargeted cost-cutting is becoming a critical challenge for companies and whole economies.

“For example, Gulf Cooperation Council countries employ large numbers of expatriates,” she said. “Those companies need to be cautious about who they let go, as it might be extremely difficult to get them back again as the economy recovers.”

Many companies, De Alwis said, see staff reduction or cuts to training budgets as the quickest way to cut costs. But she stresses that companies need to take a more strategic view of exactly who or what they cut.

“People, not machines, can take your business to the next level,” De Alwis said. “That’s the biggest mistake many companies make.”

Use a value framework

While your initial focus may be on keeping customers and sales, you should analyse all costs according to a much wider range of medium- and longer-term value-generating measures.

“All this expenditure has a purpose,” Gault said. “For example, with projects, identify the potential return on investment, then assess the impact of any cuts on future margins.”

Gartner recommended a value framework that prioritises each cost according to its associated return on investment; revenue and profit trajectory; and position in your financial strategy. This analysis can save management teams months on repairing damage caused by misdirected cost-cutting and give them a platform for future growth.

“Only a third of companies have a unifying framework to assess and evaluate costs across the enterprise — one that all budget owners and managers understand,” said Randeep Rathindran, a vice-president of research at Gartner. “Most either have multiple conflicting cost frameworks, or worse, no frameworks. This creates subjectivity and a sense of unfairness when trying to reduce costs.”

He said economic crises create opportunities to leapfrog competitors. Companies should understand which costs help them differentiate and which simply commoditise things that any competitor can copy.

Less risky cuts

Finance leaders face another pressure in that their positions tend to be precarious, with average CFO tenures under five years, according to data from Crist | Kolder. Gault said this exacerbates short-termist cost-cutting.

Finance leaders should also look at medium-term measures that reduce expenditure without affecting business operations, he said. These could include talking to procurement about using standard policies and procedures for supplier selection; consolidating suppliers; negotiating volume discounts more aggressively; and using e-auctions for economies of scale.

Another low-risk initiative is to monitor and investigate anomalies more closely, such as “maverick spend” — purchases made outside agreed contracts — and supplier invoices with no supporting purchase orders.

Another idea for large enterprises is to implement centralised order and invoice processing to boost control over costs. They could also consider ways to free up storage to share or rent out, Gault said.

Longer-term initiatives can also be less risky. These could include harmonising products and services to achieve economies of scale; opening shared-service centres; or consolidating production facilities.

“To avoid errors, it is important that board members discuss the risk of reducing costs with functional managers,” De Alwis said. “We have seen business leaders have this conversation with their staff, and it is a positive sign. Others we have seen do not have the conversation but are only keen to reduce a set percentage of costs. These businesses will make errors and expose themselves to risks.”

Engage leaders

Leaders in your business may be resistant to cutting in their area. Gartner said CFOs at top companies have addressed this by putting hard numbers around risks and opportunities associated with each cost area and then go through them with the board.

De Alwis said finance leaders with a management accounting background are ideally placed to do this, as many have business partnering experience, so they should have a keen understanding of how changes can impact the business.

“This enables them to understand the opportunities and risks of cost-cutting in each area and explain that clearly to the board,” she said.

Another effective strategy for making essential cuts effectively is to build urgency amongst leaders by making a public commitment to cost-cutting. Managers buy in when a company declares its plans to investors, as it puts their reputations on the line.

Rathindran also suggested using multi-year revenue and cost targets, which can compel investors to focus on longer-term horizons rather than short-term performance.

Gardner said there are fixed and variable costs that many companies can reduce quickly. “But, for CFOs, this is less about number-crunching and more about being a leader and managing expectations of stakeholders at all levels,” he said. “If you have a management accounting background, that experience will be crucial.”

Maintaining morale

Too much cost-cutting can make staff weary and affect morale and internal communication, so CFOs must take care.

“When downsizing, the danger is everybody stops communicating internally,” Gault said. “No one wants to stand up and make suggestions because they could become a target.”

De Alwis said having to inform an employee about the loss of his or her job is never an easy conversation.

“As a manager and leader, it is important to understand the other commitments this employee may have and others who are dependent up on their job, such as family members,” she said. “The stress of these redundancies can also affect the mental health of remaining employees of the organisation.”

Where cuts are necessary, Gault recommended communicating with staff so they understand what is being cut, why, and where people will or won’t fit into the changes.

— Tim Cooper is a freelance writer based in the UK. To comment on this article or to suggest an idea for another article, contact Neil Amato, an FM magazine senior editor, at Neil.Amato@aicpa-cima.com.