The UK economy shrunk by 5.6 per cent in the 12 months ending June 2009. This was well beyond analysts' forecasts and is the worst economic contraction for 60 years.
With that macro-economic context, it is perhaps no surprise that in client engagements at Compass Management Consulting, we are hearing CIOs and COOs tell us that they are under pressure to cut costs again this year. The new call for cuts follows on from the initial round in 2008 and managers waiting for a rise in volumes to get them out of jail in 2009 have been disappointed.
But with the low hanging fruit of easily identifiable savings already harvested, CIOs are discovering that it's hard to find savings without harming their operations. Indeed, the indiscriminate slash and burn approach to cost cutting in 2008 has left some organisations with unsustainable savings and reduced the options for future improvements. We have seen some organisations which made aggressive cuts already having to manage the unintended consequences of poor service quality.
There is also a big division in how costs should be managed between those companies with a long-term plan to improve performance and those who hurriedly adopted a slash and burn approach after the credit crunch.
Aggressive cost cutting is a reasonable tactical response to a slowdown after years of sales expansion, growth through acquisition and benign economic conditions, but it is not a strategy. The organisations whose only response to the slowdown was aggressive cuts are the ones struggling most to make savings now. They have already picked the low hanging fruit and there is nothing left within reach to deliver easy cuts this time round.
By contrast, high performing companies are typically better informed on what makes up their cost base. They also understand how they compare with their peers and take a longer term view on continuous performance improvement. They understand that cutting costs ahead of a results announcement is like slowing down your car when you see a speed camera. The tendency is to speed up afterwards and savings made in those conditions do not last.
In today's environment, with lower growth and no chance of merger or acquisition to enhance earnings, managers need to understand their business priorities and cost drivers if they are to make savings that will endure and provide a platform on which to build in future years. Some high performing companies are going further and using the downturn as a stimulus to institute fundamental change in their business, including challenging levels of demand and implementing new governance structures for their IT operations.
With a detailed set of performance information and comparisons with industry best practice, CIOs are uncovering hidden savings which will last and will not hurt business performance. Compass is typically observing second round savings opportunities of up to 20 per cent in areas such as storage, software and telecommunications alone.
The 20 per cent figure is an average. There are wide variations in performance - and thus in savings opportunities - even within companies. For example, as a result of mergers, one FTSE 100 financial services company has multiple processing centres performing the same task. The best performing of these operations is 50 per cent better that the average and the worst is 25 per cent less efficient.
In cases like these, where there is significant variance in performance across an organisation, it is not enough to cut 10 per cent or close half the centres based on geography as volumes drop. Detailed information on performance and comparison with best practice across the sector enables greater savings than 10 per cent to be made by eliminating the underperforming sites. By contrast, closing down facilities without the detail on the relative performance of each one could lead to unit costs going up if the least efficient centres were maintained.
Boards are under pressure to maintain margins even when volumes are in decline. At the same time shareholders need confidence that cost reduction programmes are going to generate sustainable savings and not have unintended consequences on sales and customer service. This means CIOs are being called on to make a forensic case for change and model costs and benefits in a way that reduces risk and ensures savings will be delivered.
In this second round of cost reductions, Compass is recommending organisations avoid indiscriminate cuts and maintain operational capacity so they can take market share as demand picks up again. There is pent-up demand in many marketplaces and the recovery may come in the same surprising and swift manner as the downturn.
When volumes return, companies need a high performance operational infrastructure to service that demand efficiently. That will only be achieved through CIOs having detailed information on their operation and how it compares with best practice in order to fine tune their capacity for maximum performance in good times as well as bad.
About the author:
Paul Teather is President UK and Rest of World at Compass Management Consulting