On average, each $1 in cost reduction can equal $5 in new revenue. In an economic environment where sales are flat and customers resist price increases, cost reduction becomes the primary way to improve the company’s bottom line and increase shareholder value. Companies have traditionally viewed cost reduction as a one-time annual exercise. For CFOs to drive meaningful improvements in a company’s financial and operational efficiencies, cost reduction should be an ongoing process. Typically the major barrier to continuous cost reduction is not from suppliers; instead, the internal resistance to change by employees is often the primary reason companies can lose out on valuable cost reduction opportunities. This is why the ability to see these opportunities is a good skill to look for in your CFO search.
CFOs should be the change catalyst in developing a company-culture of continuous cost reduction by providing strong leadership, visibility, and ongoing support to cost reduction efforts throughout the company. CFOs should set clear cost reduction goals and parameters, provide the resources to implement savings and measure the results on a frequent basis.
If a company is profitable and relatively debt-free, then employees might think that cost reduction is not necessary. Management’s philosophy may be to avoid cost increases rather than continuously drive cost reductions. The problem with this logic is that, in addition to missing profit improvement opportunities, management may be enabling costly business practices to grow within the company. By making continuous cost reduction a primary part of your company’s DNA employees will be more likely to embrace it.
Sacred vendor relationships are another significant cause of internal resistance to cost reduction. Simply put, the friendlier the relationship with the vendor, the more costly that relationship may be to your company. It is a good practice to routinely scrutinize all vendors that you have spent more than a targeted amount with over a period of time. Determine if there are contracts or service level agreements in place and if the vendor service/supply should be competitively bid.
Some companies know they are overpaying for supplies and services, but they believe they may lose the vendor’s outstanding service if they ask a vendor to reduce their prices. Ask the vendor’s decision maker for ways to keep optimal service levels at a reduced price point. Concessions may have to be made to receive the vendor price you want. Consider the potential benefits of offering a longer-term contract in return for lower prices. If your contract is structured properly, you will have the flexibility to break the contract if services suffer.
Companies often sign long-term contracts with suppliers in return for price and service concessions. In general, this is a good practice for both parties. However, companies can fall victim to the misperception that you cannot change the terms of a contract once you sign it. Consider including a continuous cost reduction clause that holds both parties accountable for delivering verifiable savings during each year of the vendor agreement.
Another cause of resistance is employees’ concern that a cost reduction initiative will make their own jobs harder. The effort to meaningfully reduce costs is considerable and can require training, preparation, and hours of execution. If employees already feel overworked and underappreciated, their resistance and skepticism can be substantial. CFOs can counter this reaction by prioritizing the areas of cost reduction that are most important (which are usually the areas that have the greatest saving opportunity) instead of trying to manage too many categories too quickly. Recognizing and rewarding employees for the “victories”—both large and small—also goes a long way.
When CFOs undertake a cost reduction project for their organization, many stakeholders are usually involved in the effort. A successful cost reduction project can last at least 18 months—a full fiscal year plus a few months to allow all annualized contracts to come due and be renegotiated and to allow adequate time to fulfill the implementation and measure success. Isolated cost-cutting exercises rarely succeed and often simply cause interdepartmental friction, with little or no long-term financial reward. CFOs may find it useful to get outside expertise to assist in developing a cost reduction program as well as assistance in its implementation. Alliance Cost Containment is one such resource and is a national cost reduction and group purchasing organization that helps small and middle market companies achieve significant cost savings www.alliancecost.com.
CFOs will increase their probability for success in creating a culture of continuous cost reduction by ensuring the company’s cost reduction programs are:
- Fully and obviously supported by top management.
- Formalized in writing.
- Tracked and reported on an ongoing basis.
- Part of the company’s strategic plan.
- Integral to the company’s annual operating plans and budgets.
- Involves the organization as a whole.
- Continuously producing needed savings.
Harvest CFO provides highly-skilled CFOs to enable CEOs, investors and management of growth and middle market companies to achieve their goals. We provide only top-quality candidates to help make your CFO search easier.