On solid footing: Is cost reduction the best way to deal with uncertainty?

“There is a massive dilemma between the two because, ultimately, the best thing for employees is growth. We see too many firms who cut costs and revenue declines,” explains Andy Blackstone, a finance director at the advertising agency M&C Saatchi Group.

While cost-cutting is often a necessary aspect of defensive financial strategies, it’s vital that CFOs approach it judiciously.

Drastic measures, such as indiscriminate layoffs or severe budget cuts, may provide short-term relief but can have long-term consequences on employee morale, innovation and the overall organisational culture.

Bobby Lane, chief executive officer of multi-disciplinary outsourcing firm Factotum, says he has seen many businesses “that have knee-jerked, panicked, cut every cost they can, getting rid of both people and therefore the revenue generators within the business”.

The starting point, says Lane, is to convert as many fixed costs to variable costs as possible and build flexibility into the cost base. For instance, by opting for flexible office space over the renewal of a long-term lease.

“While it may be more expensive per desk or per square foot, the reality is that it gives you the flexibility within your business model,” Lane says.

Andy Blackstone says the best place to look for savings is by trimming back on cost of sales by finding “things that other people are doing that you could do better yourself internally”.

For instance, having previously used Nielsen — a US data and marketing and measurement firm — to conduct audience analysis, M&C is now using its own data processing function “to target the right audience with the right message”.

“That is a classic example of something that was traditionally ‘cost of sales’ that is now part of our core.”

Outsourcing or insourcing as a cost lever

The decision between insourcing and outsourcing to trim costs is a pivotal one.

While insourcing may offer greater control, it often entails higher initial investments and ongoing operational expenses. On the other hand, outsourcing can provide cost efficiencies and access to specialised expertise.

“As labour arbitrage erodes, enterprises are expecting a higher quality of service, technology arbitrage and personalisation intelligence from outsource providers,” says Premal Parekh, a former divisional finance director at London Stock Exchange Group (LSEG) who was responsible for finding savings during LSEG’s integration of its £27 billion acquisition of Refinitiv.

Insourcing resource has its merits, especially if it drives the right behaviours, enhances the culture and improves profitability, he adds.

“You have got a headcount management question bringing the capability back in the business, it may then help develop the culture,” Parekh says. “Since we started bringing some shared services back in-house it became more of a one team initiative.”

He says LSEG’s location strategy was built on “the right people doing the right role in the right location”.

Costs can be reduced with a strategy of investing in high labour costs for a small number of people in important centres like London or New York, and then investing in other low-cost locations for people “whose roles are more transactional, or don’t need to be in front of the customer or supplier”, Parekh explains.

Sustainability

Only 11 per cent of organisations can sustain cost cuts over a three-year period, according to Gartner. This is because most cost-cutting strategies are short-term and fail to preserve the behavioural or structural change required for smart spending decisions in the future. While certain costs such as travel and expenses can be limited by policy regulations, many eliminated expenses tend to resurface, as budget owners and managers pursue expenditures and initiatives under the guise of fostering growth.

Parekh says he won’t prioritise removing costs “that are only going to have a one-off impact”.

“I prioritise driving the right business behaviours and identifying sustainable cash savings, which relate to recurring costs, to enhance enterprise value and potentially unlock reinvestment opportunities for revenue growth,” Parekh says.

“Some saving initiatives may result in shorter-term wins, while others may inadvertently risk fuelling longer-term profitability volatility,” he adds.

A “real cost take-out”, Parekh says, could involve identifying process efficiencies, improving labour productivity and reducing third-party fees and property costs.

“The pandemic has focused enterprises on their workplace strategy, and many are assessing the rationalisation of their office portfolio to reduce leasing costs, energy consumption and carbon footprint,” Parekh says.

Capital allocation

Preserving cash is essential, but finance directors must also consider strategic investments that contribute to future growth, while maintaining a healthy balance between liquidity and investment.

In practice, Parekh says this means “being really clear” how the investment aligns with the corporate strategy and if it will close the gap on either complexity, capability or capacity issues.

“Fundamentally, a strong capital allocation strategy with ruthless prioritisation can separate leading companies from the rest of the market,” he says.

For example, LSEG had a principle of “cost to achieve”, where for every pound spent to invest, a certain percentage of sustainable, incremental revenue had to be generated within a specified period.

“If an investment doesn’t fit into one of the corporate strategies, then automatically you start scratching your head and thinking ‘is this a real need-to-have?’,” explains Parekh.

Open communication lines

Clear communication with stakeholders is paramount during times of financial defence.

Transparency about the reasons behind defensive measures, the company’s long-term vision, and the strategy for navigating challenges can instil confidence in investors, employees, and customers.

“Stakeholder communication is fundamental. Change management communication is fundamental. If a business is cost cutting too much all its good staff will leave,” explains Andy Blackstone.

Bobby Lane gives the example of a client with “a great business”. However, it lost around 50 per cent of its revenue from one big customer that left overnight. He remembers “seeing the pain” in the chief executive’s face as he delivered the news.

“However, the chief executive explained what the plan was, what they were going to do with the business and how they were going to take it forward,” Lane says. “They didn’t lose one member of staff, and that business has now recovered successfully and is making very decent profits.”

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