10 Principles of Cost Transformation
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Cost Transformation is a reality that every organization has to face, several times, in its period of existence. Proper and enduring Cost Transformation provides an opportunity to reformulate an organization’s complete course. It may result in divestiture of established businesses, even profitable ones, if they do not match the Strategy or the enterprise’s most distinguishing capabilities.
Such Transformations are increasingly being spearheaded by Activist Shareholders in recent times.
Activist shareholders are investors in a company (usually hedge funds) that demand drastic changes to how business is conducted in organizations. Activist investors routinely expect management teams to reduce costs drastically over a relatively short period of time.
Data analysis indicates that activist shareholders returned double digit rewards for investors compared to the single digit returns by other investment funds. Investors are increasingly demanding activist funds in their portfolios.
Organizations should prepare for such funds by presciently looking at what changes such activist shareholders are demanding and proactively adopting an Enterprise Cost Reduction Approach.
Organizations can learn from activist investors during times of tremendous cost containment pressure, such as during a recession.
The activist investor approach to Cost Transformation, albeit unconventional, can be adapted to help organizations navigate through times of uncertainties. Companies can display farsightedness by assuming control of their cost base proactively, and develop a more robust and effective organization.
PwC’s experts extracted the following 10 principles for Cost Transformation—to aid companies in performing the activist’s role themselves.
- Transform sizably and quickly.
- Reduce headcount first.
- Rationalize what to retain, not what to eliminate.
- Create atmosphere of possibilities not dread.
- Stir the executive levels determinedly.
- Review in entirety, even the protected interests.
- Form an adjacent setup for Change Management.
- Question the manner of conducting business.
- Review end-to-end processes.
- Exhibit instant successes.
First 5 principles in the list manifest the intensified agenda of activist shareholders. Next 5 principles are focused on strategic cost reduction and rationalization—the fundamental principles around which any program should be structured.
Let us delve a little more deeply into some of the principles.
1. Transform Sizably and Quickly
Past practice of slashing costs, for e.g. by 10% over a 5-year period, do not fly with activist shareholders any more. They demand significantly more and that too, over a fairly shorter period e.g. 20% or more in 24 months, with half of it in the first 12 to 18 months.
Transforming costs sizably and quickly has been shown to provide considerable leverage. Study of 29 cost reduction efforts showed that of the 29, the companies which went big and fast were able to achieve 33% more cost reduction in almost 1/3rd of the time.
2. Reduce Headcount First
Conventional approach to cost reduction advocates eliminating unnecessary work first, then reducing the head count accordingly. This takes quite a long time to accomplish due to various reasons. New approach takes the head count reduction before process and system change.
Reducing head count first produces a void, the residual workforce has to step up and fill that space in order to keep their part of the business running. In stepping up, the remaining workers are forced to prioritize and handle jobs thus creating more effective and efficient processes.
3. Rationalize What to Retain, Not What to Eliminate
Entire expenditure is investment. Each cost is an option—not regarding what to slash from the budget, but about where to invest. Expenditures have to be rethought from their starting points—each expense to be considered eliminable. Correct choices are the ones that reduce the disparity between Strategy and Execution.
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About Mark BridgesMark Bridges is a Senior Director of Strategy at Flevy. Flevy is your go-to resource for best practices in business management, covering management topics from Strategic Planning to Operational Excellence to Digital Transformation (view full list here). Learn how the Fortune 100 and global consulting firms do it. Improve the growth and efficiency of your organization by leveraging Flevy's library of best practice methodologies and templates. Prior to Flevy, Mark worked as an Associate at McKinsey & Co. and holds an MBA from the Booth School of Business at the University of Chicago. You can connect with Mark on LinkedIn here.
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