Published In:
National Australia Bank Newsletter issue 3 2002 Date Published:
15th December 2002 Author:
Fred Marfleet
The easiest way to lift profits is to cut the fat out of costs
Cost cutting and profit increases can amount to much the same thing if handled correctly. Cost cutting does not necessarily mean the slashing-and-burning of budgets on a 'let's-see-if-this-works' whim, nor does it mean the intense scrutiny of entertainment expenses in August, before reverting to three-hour lunches in December.
But what if a company could save 20 per cent a year on its stationery spend? Or 26 per cent a year on its courier costs? Or 76 per cent annually on its printing bills?
Wouldn't that represent real savings - and an increase on the bottom line?
The truth is that a significant cause of poor business performance in Australian companies is the lack of attention given to the cost of running the business.
The reasons for this lack of attention are many, but here I am going to focus on three of them. The process of cost management and review can be difficult to manage. Tough-minded resolve is usually required, and cost-reduction initiatives are not always positively received by colleagues and staff.
Any executive who chooses to undertake a program of cost-management, then, is probably going to find themselves out on a limb and needing to show true leadership skills. And he or she is going to have to do it in today's business world, when the buyer is often at a disadvantage.
The seller, or supplier, possesses vital market knowledge that the buyer, or company, does not have because of a lack of resources, time, expertise - or a combination of all three. Consequently most, if not all, organisations overspend significantly on their business operating costs.
Experts estimate that 90 per cent of Australian businesses are overspending on day-to-day expenses, by as much as 75 per cent!
How does a company know if it's one of the 90 per cent? Our ERA website (www.expense-reduction.com.au) suggests that if a company can answer 'yes' to any of the following there is a good chance a company can reduce its business operating costs and free up profits:
YES/NO There is no centralised purchasing system. Each department seems to have its favourite suppliers and its own purchasing processes. YES/NO We always seem to be purchasing in an ad-hoc, as-needs, manner, instead of benefiting from bulk purchases. YES/NO We seem to stick to the same supplier and trust that they're giving us value for money.
MAJOR AREAS OF COST CONTROL
The main areas where costs can be rationalised include telecommunications, business travel, energy, freight, couriers, mail, office supplies, reprographics and stationery as well as cleaning, merchant card services, maintenance contracts and document storage, but of course the list is endless.
Though when reviewing overhead costs and establishing benchmarks, there are a number of other factors that need to be taken into consideration to achieve long term success in maintaining cost savings. These include improved inventory management and cost-analysis and management tools, better compliance with corporate contracts and the fact that staff remains focussed on strategic tasks. Plus the consideration that new suppliers or options provide exposure to, and the introduction of, new ideas, technologies and trends, to help enhance competitive advantages.
So how does a company implement a plan of effective cost-management? I would suggest the following:
Care about effective cost-management.
If a company's staff is complacent about financial performance and cost control, there is little chance that a cost-saving project will succeed. Executives must find the time to take an interest in reviewing expenses and reducing costs - staff generally mould their behaviour to match that of their leadership.
Cost-cutting should not be allowed to become the 'flavour of the month'
Remain motivated to keep costs in check on a regular basis. If a cost-management 'culture' is not established, employees will quickly allow your 'push' to fade away. It's important to instigate measurable strategies for cost reduction.
Over-confidence can be a killer
Companies that assume their costs are under control based on historical trends, or assume that their market knowledge is watertight run the risk of overspending through arrogance. You know what you're paying, but do you know what your competitors pay for the same products? Never assume that you know the market as well as your suppliers - and never assume that they're doing you the best deal possible.
Compare your cost-management performance to others in your industry and region. "Gather the data from outside agencies, consultants or benchmarking services," says Marfleet. "Be careful that you understand the data as it applies to your situation - data is useless unless it is interpreted correctly."
Understand what you're buying
Determine your product and service requirements. Don't purchase premium services unless absolutely necessary. Sales people will often use bait-and-switch tactics to move you on to their higher margin items. You end up buying unnecessary extras or add-on services such as maintenance agreements. Also watch for relationship-building tactics - do you really want to pay higher prices for the occasional lunch or rugby game?
Talk to your suppliers
Companies that buy the same product and the same quantities year in, year out, are probably paying way too much. Suppliers will price their offerings according to what the market will bear. Having done your research, inform suppliers that you are reviewing your costs, which have to be reduced. Then prepare to negotiate, and to comparison shop.
Stay alert
Monitoring your cost-management strategies is vital. You need to watch that staff members don't slip back into old habits, the supplier charges correct prices, and service matches the agreed specification.
USING CONSULTANTS
Most Australian companies do not have the staff resources to be able to regularly review expenses and reduce costs nor the time to monitor the market place or their suppliers.
So a company might consider using a cost management consultant to expertly manage the situation. The question that executives might ask themselves, however, is whether or not the savings will justify the sometimes substantial fees that may be charged?
The first thing to consider is what a consultant might actually be able to do for a company. For instance, does the consultant have a demonstrated track record of achieving cost reduction and the resources to deal with your size of company.
Then there is the question of the fee and how it will be paid. Arrangements can range from a fee for service to a contingency fee (a fee that is based on results). A consultant who receives their fee entirely from the supplier cannot be assumed to be independent.
Where a contingency fee is charged, it is generally expressed as a percentage of the savings obtained over a period of one year. The usual figure is around 50 per cent, although lower percentages can be found.
Sounds a lot, but remember, from the consultant's viewpoint, they are bearing all the risk in proposing a contingency fee as they are undertaking a lot of work 'up-front' before being entitled to any fee. If no savings are found, then no payment is received.
For instance, these are the steps a consultant might need to undertake where a change of supplier is deemed necessary:
The company's category spend is analysed in detail to form the basis for selecting an appropriate supplier so that that suppliers will fully understand the company's needs.
Tender documentation is prepared to ensure that there is full understanding of what is required from suppliers and that they have sufficient information to be able to offer the most favourable rates.
A detailed review of the tenders received is undertaken to ensure the best decision.
The implementation process, which typically takes 6-8 weeks is actively managed.
The bills are checked, once the new supplier is in place, to ensure that the correct rates are being applied, and 'teething' problems are resolved.
Continued reviews over a set period, dependent upon the overhead category, to ensure that the company receives all that it expects from the new arrangement.
Finally, teaching the company to understand movements in rates so that rates can be re-negotiated with the supplier in accordance with general movements in the market.
