Cost Management Key to Survival in Current Global 

Meltdown 
Nidhi Bothra
nidhibothra@rediffmail.com

The DNA of a company is its vision and mission, whether the company is able to churn
out the ‘Value for Money’ for its people, stakeholders and society at large is the company
that 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 people
can 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 streamlined
logistics and distribution network is what distinguishes Wal Mart from its peers. The
success and sustenance of every company is dependant on its strategies on cost
management.

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 the
success of a company. True, that it a culmination of more than one factor that drives the
success story of a company, but there is one factor behind each of these factors that helps
in placing these strategies right, that is a disciplined and continuous monitoring of costs.

When times are hunky dory organizations spend millions on developing that customer
contact but when times are harsh, the first thing every firm irrespective of the size ‘cuts
costs.’ We have witnessed one such recessionary period in the recent times and it would
be 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, when
the economies are bearish consumer spending is at the abyss but the cut throat
competition remains. Recession is trying time for businesses. Revenues drop, costs seem
to be unmanageable and the bottom-line becomes a bottomless pit. This is when the
Finance 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 and
the free cups of tea are stopped.

Is cost management critical only during troubled times like “Global Meltdown”? Is cost
management less important during periods of high growth and prosperity? Business
leaders tend to focus on revenue growth during normal and boom times and allow costs
to 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 cut
back costs on an ad hoc and opportunistic basis.

This is a wrong approach to cost management. In a business organization, which intends

to run efficiently, costs need to be managed (not necessarily reduced) all the time – both
prosperous and troubled times – and not with a stop-start approach. It cannot allow
unhealthy 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 prongs
are (a) Investment approach, (b) Variable Cost approach and (c) Opportunistic Savings
approach. 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 between
capital 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 on
several types of spends. The alternative criterion in such cases will be the opportunity
cost of that item – that is, the additional costs/ losses likely to be incurred, if we do not
spend on that particular item. Avoidance of the opportunity cost can be considered to be
the return on such spends.

There can be two types of investment in costs. Strategic investments are those where the
returns happen over a longer term, where as in case of Normal investments the returns are
quickly seen. Let’s take the case of Training – this is a strategic investment and the
returns are not easily visible in the short term. Even in the long term, the returns from
Training may not be easily measurable. But its strategic importance in creating an
employee development culture might be critical to the business. Often this is the area
where the management first makes the cut

Variable Cost approach

In this approach the objective is to convert some part of the fixed costs into variable
costs. When sales volumes are down, variable costs will go down. When volumes are
growing these costs will increase, but the affordability will also increase with higher sales
and 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 low
volumes/ profits the amount payable is small, but with higher volumes/profits the amount
payable goes up. Another example is advertising agency remuneration where the agency
can be paid a bonus based on sales performance of the business. Apart from payroll and
agency 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 used
extensively. Costs will continue to increase for the business with growing volumes,
where as competitors with costs of fixed nature will gain a cost advantage with
decreasing fixed costs as percentage of revenue.

Opportunistic Savings Approach

This is the approach that most bean-counters follow normally. There is not much
planning usually behind this approach, opportunistic short term savings are sought here.
This will comprise mainly arbitrary budget cuts under most expense heads, essentially to
take 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 managing
costs – Reduce, Reuse and Recycle.

The positive side of this opportunistic savings approach is that short term savings can be
quickly generated by this method. The negative side is that the arbitrariness generates
demotivation within the system which can have a long term negative impact beyond the
recession 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 business
organisation increases, fixed costs also increase but in steps. Variable costs on the other
hand increase directly in proportion to increase in volumes.

During recession when sales volumes drop substantially, management might consider
reducing capacity. Capacity reduction will mean giving up people, space, plant etc. If that
is neither possible nor desirable then the excess items/ space can be isolated as idle
capacity, 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 term
decision of minimum 2 to 3 years. Rebuilding capacity once volumes pick up again will
certainly be more expensive in the future. If the downturn is viewed to be of 6 to 12
months duration, capacity reduction will end up incurring more costs overall than what
can be saved over that period, apart from significant impact in morale and client
perception. This however remains a favorite method of most multinationals.

The crux of the story remains, whether or not crisis situation the bottom line can only
become wider when the cost ends are controlled. ITC’s ‘e-choupal’ initiative is a burning
example 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 the
farmers, cut the middleman’s share of profit, reduce the cost spent on acquisition of agri
based products without tampering with its sales volumes or productivity and what adds
icing to the cake is that this initiative has fulfilled the company’s social responsibility to
some extent.
Cost Management involves planning and setting benchmarks for a company and constant
monitoring of the set goals to ensure that the deviations if any from the benchmark are
curtailed. It involves constant reviewing standards in the light of the business scenario,
aligning the needs of the organization with that of the environment.

What is the mantra for sustenance?

If you have to survive with the cut throat competition, increase the scale of output, or cut
costs to increase margins which will help the company to maintain it bottom line in place.
Much as we emphasize the importance of cost management in the recessionary phase,
cost management is an on going activity. Is to be performed at continuous rests and
reviewed against the set standards so deviations if any are corrected or justified. Any
frivolous amount of spending cannot be justified for the stakeholders or for your own
money.

Most components of your balance sheet carry a cost for the company, servicing of the
debt or cost of capital in the company can be huge, excess of cash reserves is loss of
money generated through investments, purchase of fixed assets can be sucking out huge
amounts at one time creating cash crunch, more so cash flow mismatches can have
negative implications for the company. Hence cost management is critical at all times,
only the impact or the need of it is felt in testing times of survival. Sometimes it is simple
jugglery of figures that can do wonders to the health of the company

Companies immunity to recessionary doom - China’s growth story

One of the fresh examples of sustenance and development in the recessionary phase has
been China’s extraordinary growth story. Often Chinese products are ridiculed to be of
low quality but the fact remains that none of the countries have been able to meet the
levels of costs attained by the Chinese. There success has been by and large attributable
to the integrated manufacturing units. For instance if we compare the textile
manufacturing units set in India and in China, the attainable low costs are evident in the
latter’s case. In India cotton would come from Punjab, the yarn is purchased from
Bengal, the spinning unit is situated in Tirupati, the dyeing unit would be situated in
Delhi and the cost involved in terms of freight is tremendous. Whereas the Chinese
integrated manufacturing units does away with these bottlenecks and has been giving
Indian textile industry a run for its money inspite of better quality of textiles produced at
our end. It is called skimming the milk strategy.

Firms can compete on volumes, products, but cost disciplined firms always have that
extra edge over its competitors and are able to survive in difficult times as well. Growing
competition, sliming margins shout loud and clear that ‘survival’ is only possible, when
costs are managed well and on an on-going basis.
In the competitive business environment – the core competencies lie in strategizing
well and cost management forms a quintessential part of the same.