Tag Archives: CFO

How can we make cost cuts stick

54% of the executives surveyed by McKinsey in April indicated that they would take steps to reduce operating costs in the next 12 months, compared with 47% in February. In April, 2/3 of the respondents rated economic conditions in their countries as better than they had been six months previously, and another 2/3 expected further improvement by the end of the first half of 2010 (“Economic Conditions Snapshot, April 2010: McKinsey Global Survey results,” mckinseyquarterly.com, April 2010). Yet any successes companies have at cutting costs during the downturn will erode with time. Many executives expect some proportion of the costs cut during the recent recession to return within 12 to 18 months (“What worked in cost cutting -and what’s next: McKinsey Global Survey results,” mckinseyquarterly.com, January 2010) – and prior research found that only 10% of cost reduction programs show sustained results three years later (Suzanne P. Nimocks, Robert L. Rosiello, and Oliver Wright, “Managing overhead costs,” mckinseyquarterly.com, May 2005).

Why is it then so difficult to make cost cuts stick?

In most cases, it’s because reduction programs don’t address the true drivers of costs or are simply too difficult to maintain over time. Sometimes, managers lack deep enough insight into their own operations to set useful cost reduction targets. In the midst of a crisis, they look for easily available benchmarks, such as what similar companies have accomplished, rather than taking the time to conduct a bottom-up examination of which costs should be cut. In other cases, individual business unit heads try to meet targets with draconian measures that are unrealistic over the long term, such as across-the-board cuts that don’t differentiate between those that add value or destroy it. In still others, managers use inaccurate or incomplete data to track costs, thus missing important opportunities and confounding efforts to ensure accountability.

Some possible solutions:

Focus on how to cut, not just how much

Benchmarks matter. External ones on some measures may be difficult to get, but where they are available – for example, on travel expenses – they can enable managers to compare performance across different units and identify real differences, as well as trade-offs that may not be in line with the organization’s overall strategy. Internal benchmarks are easier to access and provide great insights, especially because managers are more likely to understand and adjust for differences among their company’s organizational units than among different companies represented by external benchmarks.

P&L accounting data is not enough to make lasting decisions

Unfortunately, few companies have the kinds of systems they need to track costs at a fine-grained level – and they face a number of challenges in establishing them. Multiple data systems may make it difficult to aggregate and compare data from different geographies. Inconsistent accounting practices between businesses or time periods may lead to significant distortions. Changes in organizational structure (as a result of acquisitions, divestitures, or even changes in the allocation of overhead costs) may similarly distort tracking.

Clearly link cost management and strategy

Strategy must lead cost-cutting efforts, not vice versa. The goal cannot be merely to meet a bottom-line target. Indeed, among participants in a November 2009 survey, those who worked for companies that took an across-the-board approach to cost cutting in the recent downturn doubt that the cuts are sustainable. Those who predicted that the cuts could be sustained over the next 18 months were more likely to say that their companies chose a targeted approach. (“What worked in cost cutting – and what’s next: McKinsey Global Survey results,” mckinseyquarterly.com, January 2010).

Yet, many companies do not explicitly link cost reduction initiatives to broader strategic plans. As a result, reduction targets are set so that each business unit does “its share” – which starves high-performing units of the resources needed for valuable growth investments while generating only meager improvements at poorly performing units. Moreover, initiatives in one area of a business often have unintended negative consequences for the company as a whole.

Aim at results for 2-3 years not just 12 months

Most companies treat cost management as a one-off exercise driven by the need to manage short-term profit targets. Yet such hasty cost-cutting activity typically goes into reverse once the pressure is removed and rarely results in sustainable changes in cost structure. A better approach is to use the initial cost reduction program as an opportunity to build a competency in cost management rather than in cost reduction.

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A year after the global economic system nearly collapsed (II)

McKinsey received responses from 1,677 executives, representing all regions, industries, company sizes, and functional specialties for their last Global Economic Conditions Survey, dated September 2009:

  • Executives in China are no likelier than others to say that an upturn has already begun, but they are particularly hopeful about their own country’s prospects: 82% expect its GDP to increase in 2009, and 30% expect its GDP to regain pre-crisis levels in 2010.
  • As has been true throughout the crisis, large public companies are much likelier to decrease the size of their workforce than small private ones – although these two kinds of companies don’t have different expectations for customer demand or profits.
  • Fears that countries will restrict international trade seem to have receded in the past six months: 42% of respondents now expect it to rise in the long term, compared with just 16% half a year ago.
  • Although just under half of all respondents expect tighter credit at the national level over the next five years, less than 10% expect sales to fall because consumers or businesses can’t get credit.

What’s next?

  • Most companies are managing in a new normal, with an enlarged role for government and lower long-term growth expectations.
  • Innovation is more important than ever; the companies that have the highest hopes for their own futures are likeliest to be focusing on it.
  • January was the month when executives expressed the direst views about the economy. They now look forward to economic growth, but few expect a quick, full recovery.
  • Executives indicate that the past year has slowed but not stopped globalization – and that skepticism about the value of free markets will continue as well.

For more details, you may find the full report at:
http://www.mckinseyquarterly.com

Corporate social responsibility: the importance of corporate environmental, social, and governance programs

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A recent McKinsey Survey shows that the perceived importance of corporate environmental, social, and governance programs has soared in recent years, as executives, investors, and regulators have grown increasingly aware that such programs can mitigate corporate crises and build reputations. However, no consensus has emerged to define whether and how such programs create shareholder value, how to measure that value, or how to benchmark financial performance from company to company.

The McKinsey survey asked CFOs, investment professionals, institutional investors, and corporate social responsibility professionals from around the world to identify whether and how environmental, social, and governance programs create value and how much value they create.

Results show that, among respondents who have an opinion, 67% of CFOs and 75% of investment professionals agree that environmental, social, and governance activities do create value for their shareholders in normal economic times. By wide margins, CFOs, investment professionals, and corporate social responsibility professionals agree that maintaining a good corporate reputation or brand equity is the most important way these programs create value.

Respondents to this survey are split over whether putting a financial value on social programs would reduce the reputational benefits to companies: slightly more believe stakeholders view financial value creation as important than believe it’s a distraction.

Investment professionals generally agree that the global economic turmoil has increased the importance of governance programs and decreased the importance of environmental programs to creating shareholder value. Respondents do, however, largely agree that environmental and social programs will create value over the long term, and that governance programs create value in both the short and long terms.

Some 67% of CFOs, investment professionals, and corporate social responsibility professionals also believe that the shareholder value created by environmental and governance programs will increase in the next five years relative to their contributions before the crisis. Expectations of social programs are more modest; half of respondents say these programs will contribute more value.

Most respondents cite attracting, motivating, and retaining talented employees as one way that environmental, social, and governance programs improve a company’s financial performance, but few respondents think communications could be improved by reporting data in this area.

Some future perspectives
• A clear first step would be to develop metrics that focus on integrating the financial effects of environmental, social, and governance programs with the rest of the company’s finances.
• A few companies see environmental, social, and governance programs as an opportunity to create new revenue streams. Given investors’ demand for financial data, companies could benefit from explicitly including these programs and their revenue streams in planning and reporting.
• Corporate social responsibility professionals can help their own companies and their investors fully value their environmental, social, and governance programs by understanding how various stakeholders see them and by learning to communicate their value.

McKinsey’s survey included responses from 238 CFOs, investment professionals, and finance executives from the full range of industries and regions and it was conducted along with a simultaneous survey of 127 corporate social responsibility professionals and socially responsible institutional investors.

Managing in a downturn: three key areas of focus that management could consider in managing risk

Managing cash flow is vital to anyone’s business, especially in a downturn: any company needs to be in control of its own cash flow. You may already know that, in a downturn, your stakeholders are looking at your costs like they never have before; this is the best time to be proactive and think strategically about cost.

Here are three key areas of focus that management could consider in managing risk:

1. Understand your own data. Going through 50 pages monthly management accounts does not help you control your business. Reduce the report to an ideal 1 page summary which covers all of the key performance indicators that you have agreed as being significant to your business.
2. Settle clear ownership. Customer services, production, procurement, finance – each believe they have a right to control the cash in their domain. However, you should consider that none of them have a holistic view of your business requirements. Management of cash should clearly be stated as the responsibility of the CFO and/or the board of directors.
3. Communicate effectively with all stakeholders. On the one hand, for example, your staff need to understand that appropriate credit control is an important part of the customer experience, even if the payment is not going to be made to terms. On the other hand, as we all know, banks do not like surprises. If you will be able to predict difficulties in cash collection, you should be able to manage the banks’ expectations as well.

All the above may sound like common sense, but you would be surprised to find out in how many companies this is not a common practice. If you have decided to handle cost more strategically, here are some simple practical tips on how to do it:

  • correctly identify the drivers of cost in your company: ask yourself if there are areas of your company and cost that are destroying value;
  • improve the processes around those areas or simply eliminate the cost.

However, you cannot always take out costs quickly, as major projects may be on roll. If this is the case, you could take a more measured approach:

  • in the first phase, look at your major project spend and ask yourself what can you do differently; have a look at your supplier agreements, some of them will allow you some space to take long term decisions;
  • in the second phase look at your own levels of bureaucracy and simplify procedure to the extend of compliance and operational efficiency;
  • in the third phase, re-analyse your project and look for its competitive strength or even opportunities. The business world is moving and, since the first two phases could take from a few months to years, depending on project extend, you could redefine it in terms of new market opportunities.

Five trends that will shape business technology in 2009 and five tips for a successful CIO during crisis

McKinsey’s report “Five trends that will shape business technology in 2009” shows that, since the last downturn, technology budgets are larger, businesses have automated more processes, employees make greater use of tech-based productivity tools, and e-commerce has moved to the core of day-to-day operations. At the same time, IT organizations have established better mechanisms to govern IT decision making and have consolidated local IT operations to cut costs.

Based on this combination of cost pressures and IT requirements McKinsey’s report suggests that:

1) The year 2009 will be a tipping point for the CFO’s involvement with IT. They may sign outsourcing deals, sell and lease back hard assets, place favourable vendor financing at the core of hardware and software purchasing decisions.
1st Tip: Successful CIOs will give the senior-management team practical ideas on how to optimize cash.

2) IT budgets in many organizations will come under tremendous pressure in 2009, reducing investment for new business capabilities.
2nd Tip: Successful CIOs will have to position themselves as honest brokers, pushing hard to evaluate IT investments in a fact-based way.

3) Senior executives that have used IT less successfully in the past will probably throw up their hands and shut off all discretionary IT projects for the duration of the downturn.
3rd Tip: The most effective course of CIOs will be to explain what it would take to improve the value equation for IT investments.

4) Policy makers and regulators will probably demand that IT systems capture more and better data in order to gain greater insight into and control over how banks manage risk, pharma companies manage drugs, and industrial companies affect the environment.
4th Tip: Successful CIOs should enhance their relationships with internal legal and corporate-affairs teams and be prepared to engage productively with regulators.

5) The vendor landscape will likely follow the current downward pressure on aggregate demand and massive uncertainty in currency markets. New entrants will grow rapidly and some players could experience significant reverses.
5th Tip: Successful CIOs will manage their vendor relationships as a portfolio so they will be well positioned as new winners evolve. CIOs will also need to be vigilant about how to manage transitions created by the consolidation or weakness of some service providers.

You may find McKinsey’s report at:
http://www.mckinseyquarterly.com/Organization/Change_Management/Five_trends_that_will_shape_business_technology_in_2009_2296