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Cost Management Key to Survival in Current Global Meltdown

Cost Management Key to Survival in Current Global Meltdown

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Published by Nidhi Bothra

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Published by: Nidhi Bothra on Jun 05, 2010
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Nidhi Bothra
nidhibothra@rediffmail.com The DNA of a company is its vision and mission, whether the company is able to churnout the ‘Value for Money’ for its people, stakeholders and society at large is the companythat is able to sustain itself in the long run. The success of likes of Wal Mart, Reliance,Microsoft are a standing testimony to the story, today they are brands with which peoplecan associate themselves well. What drives these companies to become the eye candies of its customers is the simple –
Value for Money.
What defines the success of Wal Mart, for instance, is its strong cost cutting physics.Wal-Mart's everyday-low-price position and its low cost structure with streamlinedlogistics and distribution network is what distinguishes Wal Mart from its peers. Thesuccess and sustenance of every company is dependant on its strategies on costmanagement.Many schools of thoughts may contest that, sales volumes, dynamic marketing tactics,product’s unique selling point are equally if not more of the driving forces behind thesuccess of a company. True, that it a culmination of more than one factor that drives thesuccess story of a company, but there is one factor behind each of these factors that helpsin placing these strategies right, that is a disciplined and continuous monitoring of costs.When times are hunky dory organizations spend millions on developing that customercontact but when times are harsh, the first thing every firm irrespective of the size ‘cutscosts.’ We have witnessed one such recessionary period in the recent times and it wouldbe logical to take cues from the recent recessionary phase to reiterate our point.
What marks the recessionary phase:
It is the Darwin’s theory that holds much relevance especially in such testing times, whenthe economies are bearish consumer spending is at the abyss but the cut throatcompetition remains. Recession is trying time for businesses. Revenues drop, costs seemto be unmanageable and the bottom-line becomes a bottomless pit. This is when theFinance guys are brought in to take charge and manage costs. Headcount is pink-slipped,travel budget is reduced, long distance calls are banned, stationery supply is curtailed andthe free cups of tea are stopped.Is cost management critical only during troubled times like “Global Meltdown”? Is costmanagement less important during periods of high growth and prosperity? Businessleaders tend to focus on revenue growth during normal and boom times and allow coststo inflate beyond necessity. Then, during slowdown period and recession they switch
back focus to cost management by letting loose the bean-counters, who then begin to cutback costs on an ad hoc and opportunistic basis.This is a wrong approach to cost management. In a business organization, which intendsto run efficiently, costs need to be managed (not necessarily reduced) all the time – bothprosperous and troubled times – and not with a stop-start approach. It cannot allowunhealthy accumulation of fat in any segment or type of cost at any time.During recession period there will be a fourth point to consider as well. The three prongsare (a) Investment approach, (b) Variable Cost approach and (c) Opportunistic Savingsapproach. During recession period I will also consider Capacity Reduction approach.
Investment Approach
All costs are viewed as investments and not as expenses. Therefore for every cost item,we need to evaluate the returns generated by that spend (with no distinction betweencapital and revenue expenditure). Returns generated from payouts on rent, utilities, travel,marketing spends etc will be evaluated. Yes, it will be difficult to evaluate returns onseveral types of spends. The alternative criterion in such cases will be the opportunitycost of that item – that is, the additional costs/ losses likely to be incurred, if we do notspend on that particular item. Avoidance of the opportunity cost can be considered to bethe return on such spends.There can be two types of investment in costs. Strategic investments are those where thereturns happen over a longer term, where as in case of Normal investments the returns arequickly seen. Let’s take the case of Training – this is a strategic investment and thereturns are not easily visible in the short term. Even in the long term, the returns fromTraining may not be easily measurable. But its strategic importance in creating anemployee development culture might be critical to the business. Often this is the areawhere the management first makes the cut
Variable Cost approach
In this approach the objective is to convert some part of the fixed costs into variablecosts. When sales volumes are down, variable costs will go down. When volumes aregrowing these costs will increase, but the affordability will also increase with higher salesand consequent higher cash generation.A popular example of this approach is the variable pay component in the salary package.It is not a piece rate system, but a performance based incentive system where at lowvolumes/ profits the amount payable is small, but with higher volumes/profits the amountpayable goes up. Another example is advertising agency remuneration where the agencycan be paid a bonus based on sales performance of the business. Apart from payroll andagency remuneration, this approach can be applied to other costs of fixed nature as well,through innovative negotiations with vendors.
A word of caution – the approach can boomerang during periods of growth if usedextensively. Costs will continue to increase for the business with growing volumes,where as competitors with costs of fixed nature will gain a cost advantage withdecreasing fixed costs as percentage of revenue.
Opportunistic Savings Approach
This is the approach that most bean-counters follow normally. There is not muchplanning usually behind this approach, opportunistic short term savings are sought here.This will comprise mainly arbitrary budget cuts under most expense heads, essentially totake away part of the cushion that was allowed to be built into budgets in the first place.We could follow in this approach a simple method of 3 Rs, for evaluating and managingcosts – Reduce, Reuse and Recycle.The positive side of this opportunistic savings approach is that short term savings can bequickly generated by this method. The negative side is that the arbitrariness generatesdemotivation within the system which can have a long term negative impact beyond therecession period.
Capacity Reduction
Fixed costs are called capacity costs, because they are of fixed nature for a given level of capacity of production/ sales. When capacity to do work or to produce/ sell by a businessorganisation increases, fixed costs also increase but in steps. Variable costs on the otherhand increase directly in proportion to increase in volumes.During recession when sales volumes drop substantially, management might considerreducing capacity. Capacity reduction will mean giving up people, space, plant etc. If thatis neither possible nor desirable then the excess items/ space can be isolated as idlecapacity, so that expenditure on related maintenance and utilities are not incurred.Capacity reduction is not a short term opportunistic decision; it is at least a medium termdecision of minimum 2 to 3 years. Rebuilding capacity once volumes pick up again willcertainly be more expensive in the future. If the downturn is viewed to be of 6 to 12months duration, capacity reduction will end up incurring more costs overall than whatcan be saved over that period, apart from significant impact in morale and clientperception. This however remains a favorite method of most multinationals.The crux of the story remains, whether or not crisis situation the bottom line can onlybecome wider when the cost ends are controlled. ITC’s ‘e-choupal’ initiative is a burningexample before us. ITC has been able to do away with the middlemen in the business.With a slight fine tuning of its strategies, it has been able to provide better revenues to thefarmers, cut the middleman’s share of profit, reduce the cost spent on acquisition of agribased products without tampering with its sales volumes or productivity and what addsicing to the cake is that this initiative has fulfilled the company’s social responsibility tosome extent.

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