Five ways CFOs can make cost cuts stick

Successes in cost cutting erode with time. Here’s how to make them
last.

McKinsey Quarterly- May 2010

Presented By: -
Ashutosh Jain
Why is it so difficult to make cost cuts
stick?
 It’sbecause reduction programs don’t address the true
drivers of costs or are simply too difficult to maintain
over time.
 Sometimes, managers lack deep enough insight into
their own operations to set useful cost reduction
targets.
 In the midst of a crisis, they look for easily available
benchmarks, such as what similar companies have
accomplished, rather than taking the time to conduct a
bottom-up examination of which costs can—and
should—be cut.
Individual business unit heads try to meet
targets with draconian measures that are
unrealistic over the long term, such as across-
the-board cuts that don’t differentiate between
those that add value or destroy it.
Managers use inaccurate or incomplete data to
track costs, thus missing important
opportunities and confounding efforts to
ensure accountability.
Five ways CFOs can make cost cuts stick

1. Assign accountability at the right level

2. Focus on how to cut, not just how much
3. Don’t let P&L accounting data get in the
way of cost reduction
4. Clearly articulate the link between cost
management and strategy
5. Treat cost management as an ongoing
exercise
Assign accountability at the right level
The involvement of top managers is not by itself
sufficient—especially in a period of growth,
when they naturally turn their attention to
other initiatives.
Most cost innovation happens at a very small
and practical level. Breaking costs out in this
way helps managers to find the specific groups
or individuals responsible for them and to
identify and swiftly deal with pockets of
expense mismanagement.
 Take, for example, the cost-cutting program at one
multinational high-tech company. Initially, the CFO
had little actionable information on who was
responsible for which costs. Profit-and-loss (P&L)
statements were reported only for product-based
business units, even though geographic sales units had
higher costs. This lack of detail made it very difficult to
assign responsibility for overall cost reductions.
 To resolve these issues, the company redefined the way
it collected and reported information, to ensure that
costs were broken out for each of 100 organizational
units.
Focus on how to cut, not just how much
Cost reduction programs often lose
effectiveness over time because top
management kicks off the effort with broad
cost reduction targets (“How much do we want
to save?”) but then leaves decisions on how to
meet those targets to individual line managers.
The benefits of such cost cuts are likely to be
illusory, short lived, and at times damaging to
long-term value creation.
Amore enduring approach includes
changing the way people think about
costs by, for example, setting new policies
and procedures and then modeling the
desired behavior.
 Don’t let P&L accounting data get in
the way of cost reduction
 CFOs often manage cost reduction efforts by tracking
accounting data in their companies’ P&L statements.
These can be a useful starting point in a crisis, if other
data are unavailable. But over the long term, P&L
categories, such as overall SG&A costs, don’t give the
kind of per-unit insights that help focus cuts in, say,
travel expenses on the units that can best afford to cut
them.
 Inconsistent accounting practices between businesses
or time periods may lead to significant distortions.
To resolve the problem, companies must
continuously track, in some detail, the
expenses behind the P&L to identify areas
of underperformance, without worrying
about the formal accounting of the costs.
Identifying, measuring, and controlling
their most important drivers is more
important than how the savings are
booked and reported.
Clearly articulate the link between cost
management and strategy

 Strategy must lead cost-cutting efforts, not vice versa.

 To create value through cost cutting, managers need to
understand the best ways to allocate operating
expenses, such as selling costs and R&D. To do so, they
must understand, at the most detailed possible level, the
return on invested capital (ROIC) and the growth of the
markets in which a company plays. Mapping costs
against business units and geographies will reveal both
opportunities for cost reductions and areas in which
the business should increase its investments to take
advantage of growth opportunities or to “double down”
in high-ROIC businesses.
Treat cost management as an ongoing
exercise
Most companies treat cost management
as a one-off exercise driven by the need
to manage short-term profit targets—and
some of these exercises do succeed in the
short term because of constant pressure
from the CEO or CFO.
such hasty cost-cutting activity typically
goes into reverse once the pressure is
removed
A better approach is to use the initial cost
reduction program as an opportunity to build a
competency in cost management rather than in
mere cost reduction. Cost-management
programs need to be scoped as two- to three-
year initiatives rather than as immediate-term
efforts with one-year horizons. Also, effective
cost-management programs, by their very
nature, include plans for dealing with changing
business conditions—for instance, by adjusting
for activity-level changes, competitive drivers,
or both.
Conclusion
Companies must improve their processes
and capabilities if they hope to reduce or
contain costs in a sustainable manner.
Rethinking common practices in cost
management should help to realize this
goal. In particular, achieving a more
fine-grained perspective on where costs
occur should be a centerpiece of any
successful cost-management program.
THANK YOU