The changing nature of business (pt 9): creating a cost-conscious culture
While 88% of finance leaders believe that their focus on total cost savings has increased, according to recent research, 71% of them are continuing to see indirect costs growing and labor costs shrinking. And yet headcount reductions remain a top priority for cost reductions…
The changing nature of how enterprise operates has driven a dramatic shift in the third party cost base, and the resulting supply chains. For years, the default strategy for large cost reduction programs, in light of diminishing profitability, has been to shrink headcount. But labor costs as a percentage of revenue have significantly shrunk, and the third party cost base has grown, so the impact it can have today on profitability is limited.
Furthermore, reducing headcount is typically a regressive approach, creating diminished employee morale out of uncertainty. Losing staff also means seeing experience, corporate knowledge, valuable relationships and even intellectual property leave the enterprise. It can limit flexibility to act when circumstances change. And there are wasted costs in compensation and subsequent recruitment and training fees when overall performance improves.
In contrast, as the third party cost base has rapidly expanded, opportunities lie in driving efficiencies in non-labor costs, and the benefits go beyond increased profitability – into cash flow, process improvements, improved risk mitigation, etc. It enables greater visibility of all costs and buying behaviors across the business. From there, improvements to these buying behaviors can be identified and implemented quickly, resulting in enhanced business performance.
However, the success of any supply-related cost management program is dependent on how well the finance and procurement functions work together. The former has overall visibility and control of a enterprise’s cost base; the latter has the potential to maximize value for money from its supply chain and improve supplier performance.
Promoting a cost-culture through collaboration
Most organizations are constrained in their ability to deliver cost management changes - even if they explicitly want to do so. Our research reveals:
- While 80% of finance leaders are confident of procurement’s capacity to manage their costs, 58% expressed low satisfaction with their current procurement capabilities
- Only 7% strongly agree that their procurement teams have the flexibility to scale up or down depending on business demand
- Only 27% of respondents strongly believe that their procurement team enables the business to identify and capture verifiable cost savings. And 45% of respondents do not believe their CFO or senior finance teams can always see reported cost savings on the bottom line
- Almost a third of respondents strongly disagree that their team is able to influence stakeholders (i.e. budget holders) fully
- Only 17% strongly agree that their procurement function thinks and acts from a proactive position
Procurement should be able to help finance leaders reduce risk in the supply chain, gain greater visibility of where costs originate within the business, and improve control over the cost base. Finance should provide procurement with the leadership, support and guidance to drive the necessary change.
This collaborative partnership will increase visibility and encourage better buying behavior across the business. The compound effect of which will deliver a positive message to shareholders that the enterprise has its costs under control, instills better practices and prepares the business for future growth.
Our latest research reveals that businesses spend, on average, two-thirds of their revenue on non-labor costs – 68.3% in 2011. This far outstrips their collective labor costs, which averaged just 12.9% of their revenue. Yet headcount reduction is traditionally seen as the best way to tackle cost. This raises a number of questions:
- Are businesses ensuring that their non-labor cost base is being effectively managed?
- If not, why not?
- And what are the potential benefits of making that investment?