The changing nature of business: what next?
This is the concluding chapter for the changing nature of business series. We hope you have enjoyed the series and the research.
NOTE: I would like to thank those who have contributed to this series, research and our other blogs throughout the year. All of us here at Proxima would like to wish everyone a safe, peaceful and merry festive season and a very happy new year.
The nature of the cost base has changed
The economic cycle has reached a point where traditional cost-cutting (e.g. labor cuts) will not, by itself, maintain the financial performance of a business. With more than two-thirds of revenue being spent on non-labor costs, businesses should be aiming for improved performance and real value for money from their supply chains, leading to a better ability to sustain value for shareholders.
The cost profiles of businesses are dramatically different to the traditional models of yesteryear:
- Average labor costs (as a percentage of revenue) are surprisingly low – only 12.9% in 2011
- Average non-labor costs (at 68.3%) outweigh its labor costs by more than five times
The potential for the FTSE 350 to increase its profitability by reducing its non-labor costs, even modestly, is significant:
- Bringing non-labor and third party costs under control represents a greater opportunity to improve profitability than a more traditional focus on labor costs
- The opportunity to improve profitability is greater in certain sectors, however our research suggests that most organizations are constrained in their ability to deliver cost management changes - even if they explicitly want to do so.
Two questions finance leaders should therefore consider are:
- Is the investment in how the non-labor cost base is managed proportionate to the overall cost?
- How does this level of investment compare with investment in managing labor costs, which is five times smaller in value?
Align finance and procurement
The research also makes clear that for the best results to be achieved, finance and procurement must work together more closely. In doing so, CFOs and finance leaders can gain greater visibility on where costs are being incurred, which suppliers are delivering best value for money and the capabilities that procurement can bring to bear in the financial planning and decision making processes.
In return, procurement can get a clearer view of the company’s wider corporate objectives, so that it can implement cost management programs that support those aims. This joined-up approach means that the business has a cost base, which gives it the flexibility to grow during times of growth and redeploy funds as conditions become more challenging.
Secure long-term benefits
Labor reductions will only, in the end, achieve one positive result – the removal of that cost from the business. However, the emotional cost subsequently rises when the impact on stakeholders is taken into account. In comparison, rigorous management of non-labor costs can help to make organizations leaner and fitter.
At the same time, experience shows that it can enable innovation, improve risk control measures through better visibility, enhance financial controls and reassure investors that the company will deliver the returns they expect. Stronger management of non-labor costs can play a meaningful role in enabling the company to produce the results that their stakeholders expect and demand, providing the business with a platform from which it can grow and develop in the future. Modest improvements to non-labor costs can have a meaningful effect on shareholder value and profitability, the comparator that leaders consider the key barometer when gauging a company’s performance.
Lay foundations for the future
With economic conditions likely to remain turbulent for the foreseeable future, a choice for finance leaders presents itself. Do they continue along the well-trodden path of maintaining revenues and hoping to keep profits in line with forecasts? Or will they seize the opportunity to deliver meaningful and sustained increases to underlying profitability through proactive management of non-labor costs?
The old adage of opportunities emerging from challenges has never been more relevant. Now is the time for businesses to capitalize on the latent opportunity and strengthen their platform for future growth. Those enterprises that do so today will have a distinct competitive advantage when the storm clouds finally subside.
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?