How the 'Shareholder Spring' should evolve
Following on from a previous post on this topic, the Shareholder Spring should turn its attention away from executive pay, and towards an area that has a far greater opportunity to improve profitability and shareholder returns – third party costs.
Senior executives are again facing a tough time with regards to pay in front of shareholders and investment institutions. It’s perhaps not surprising as it’s an easy target thanks to pay levels being freely available, and significantly above the national average.
But shareholders and institutional investors don’t seem to realize the limited positive impact on business performance that reducing executive pay will produce. And that’s because across the FTSE 350, on average, only 12% of revenue is spent on labor. So reducing the senior executives pay is not going to materially improve profitability through a reduced wage bill. Yet better talent will improve overall business performance.
Surely investors would rather pay market or even above market levels to attract top talent to safeguard their investment, than pay lower levels for inexperienced management, and risk worsening the business performance.
But there’s a much bigger point in this debate which is being over looked – an opportunity for the pressure the Shareholder Spring is able to apply to materially affect profitability.
Shareholder Spring 2.0
In contrast to the 12% of revenue being spent on labor, a massive 68% is spent on non-labor and supplier related costs (this by the way, is also freely available information).
So if you reduce your labor costs by 1%, you increase profitability by 0.8%. Yet if you reduce your non-labor costs by the same 1%, you increase profitability by 3.6% - five times greater.
It won’t be long before the Shareholder Spring starts to focus on other areas. And it is important that senior executives understand where the next round of scrutiny could focus.
As the Shareholder Spring inevitably evolves, we should expect to see an increased level of scrutiny from investors on the 68% of revenue that is spent on external suppliers.
Before investors begin their interrogation, senior executives need to absolutely understand these costs, be confident that about the quality of commercial thinking that goes into how they are invested, demonstrate excellent control over them, and ultimately ensure that value for money is achieved.
How confident do you think business leaders are that 68% of their revenues are being excellently managed?
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?