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The current financial crisis or global financial meltdown has been called the worst financial crisis since the one related to the Great Depression by leading economists, and it contributed to the failure of key businesses, declines in consumer wealth, substantial financial commitments incurred by governments, and a significant decline in economic activity. Experts tried to find out the causes and solutions and as a result both market-based and regulatory solutions have been implemented or are under consideration, while significant risks remain for the world economy.
While periods of economic instability are not unusual in today's global marketplace, the current economic slowdown which started somewhere in 2008, seems particularly challenging for companies all over the world. Sharply higher prices of food, oil and other commodities, a falling dollar, tightening credit conditions and plunging stock market prices have been accompanied by warnings that the world's major economies confront a new era of unusually difficult challenges.
How to start and where to start? What should be done first? Does the order matter? Or should everything be done at once? These are the common questions that rise in the mind of every executive. While some strategies might be right for an organization today, unforeseen negative consequences could have a lasting impact depending on how the crisis plays out.
Global Meltdown - Cause and Impact
Volatile economic conditions are creating churn in business objectives, making planning and execution exceptionally difficult- companies feel as though they're flying blind. This recession is not like any other economic downturns of the recent past. Its force, speed, and impact are greater, and its scope is more global. This recession is not the product of a single market meltdown. Rather, it was spawned by the perfect storm of destructive economic conditions- first the run-up in real estate values fueled by easy credit and extreme leverage, and then the consequent freezing of the financial infrastructure and the clampdown on credit. Both leaders and laggards in every industry profited from the euphoric consumption let loose by the speculative bubble. Now that it has burst, senior managers at every company need to dispassionately reassess where they stand competitively and financially.
Though the immediate cause or trigger of the crisis was the bursting of the United States housing bubble yet, the following are some of the directly or indirectly assigned causes of the global financial meltdown:
Growth of Housing Bubble in U.S.
Easy Credit Conditions
Increased debt burden or over leveraging
Financial Innovation and Complexity
All the above mentioned causes led to the world economy to a major global meltdown, which has affected both the service as well as industrial sector adversely. Faced with the most unprecedented economic conditions in living memory, the issue of improving the financial position of a business has become the challenge for everyone and hence major projects and expansion plans are being reviewed by the corporate sector and they have started focusing on reducing costs and borrowings. Consequently, earning profit is getting tougher day by day as revenue is declining due to decline in sales. Though the concept of Profitability and Cost Management (PCM) comprises both the revenue and cost side of the business, there is usually a stronger focus on cost management, particularly indirect costs. Indirect costs are all costs not directly associated with the production and sales of products and services, such as marketing, finance, IT, facility management, HR, and other supporting functions. Allocating revenues to operations is a fairly straightforward process. It is usually clear which product was sold to which customer, and can be counted as revenue in a particular period. However, it is not always easy to attribute revenue to organizational divisions, business units or departments. And it is harder to define a method to allocate overhead and other forms of indirect costs to business processes. Despite its history and available best practices, profitability management remains an elusive goal. According to a 2007KPMG survey of more than 400 companies worldwide, nine out of 10 cost reduction programs fail to achieve their targets, and gains that are achieved are typically short-lived. One of the most common pitfalls cited is that cost drivers are not clear, and as a result, cost-cutting initiatives are not targeted at the right places. [i] iiHence it is very much imperative for the companies to understand and apply the right strategy of cost management in order to derive its benefits.
Cost Management - What?
There is no single accepted definition for this term, because it has such broad applications and possible strategies. Cost management is defined as "a set of techniques and methods for controlling and improving a company's activities and processes, its products and services" to achieve continuous improvement and deal with global competition; with commitment from top management and worker involvement. Cost management approaches include accounting simplification, back flush accounting for just-in-time (JIT) systems, and resource accounting. Accounting simplification is the process by which an accounting system is made to match the accounting flow emanating from the natural processes of an operation without disrupting the process. Back flush systems, such as the one used by Harley-Davidson, is a system focusing on outputs which traces the outputs backwards in order to allocate costs between inventory and the costs of sold goods. Resource costing is used in JIT systems and under Total Quality Management concepts under which measurements are prioritized. It improves the accuracy of pricing and reduces costs by eliminating standard costs and replacing with the actual costs. In order to ascertain actual costs, the system is based on cost drivers, which improves the accuracy of product costs because it traces conversion costs to products based on activity.
Conventional cost management usually follows the formula that when the economy deteriorates, companies should reduce costs to become profitable again. This cut-and-slash approach to cost management can lead to a loss of customers and market share, unsustainable turnover of experienced staff, and inefficiencies in the long term. In comparison, strategic cost management holds that cost should not be reduced at the expense of business strategy and that costs must be managed for economic value. Costs should not be managed in isolation to each other, but always with regards to the value generated from the costs spent.
Cost Management - Why?
Cost management is the buzzword of the modern business world. It involves managers and describes their short-term and long-term plans and programs to reduce the cost of their products and services, and at the same time, increase the value of the company in the market. It involves the continuous planning and control of costs. It is the process by which companies control and plan the costs of doing business. Normally each segment or the department of the business has its customized cost management plans, and companies as a whole also integrate cost management into their overall business model. Effective implementation of cost management will translate into reduced costs of production for products and services, as well as increased value being delivered to the customer.
For a company's management to be effective overall, cost management must be an integral feature of it. It is easiest to understand this concept if it is explained in the context of a single project. For instance, before a project is started, the anticipated costs should be identified and measured. These expenses should then be approved before any purchasing occurs. During the process of completing a project, all incurred costs should be noted and kept in a record of some kind, to help ensure that the costs are controlled and kept in line with initial expectations, to the extent that this is possible.
Taking this approach to cost management, it will help a company to determine whether they accurately estimated expenses at first, and will help them more closely predict expenses in the future. Any overspending can also be monitored in this way, and either eliminated in future projects or specifically approved if the expense was necessary. Cost management cannot be used in isolation; projects must be organized and tailored with this strategy in mind.
Starting a project with cost management in mind will help to avoid certain pitfalls that may be present otherwise. If the objectives of the project are not clearly defined at first, or are changed during the course of the project, cost over-runs will be more likely. If costs are not fully researched before the project, they may be underestimated, thereby inflating the expectation of the project's success unrealistically. Construction projects are subject to their own particular challenges; these can include constraints in the form of laws and regulations that must be planned around. If the project is completely and clearly defined, this will facilitate effective management of the costs it will incur. Effective cost management strategies will help a team deliver a finished project within the allocated budget, while also making it as valuable as possible to the company. There is always the possibility of unexpected costs, but preparation in the form of cost management will likely make them much easier to deal with when they occur.
Cost management is not an issue only for the CEO or for senior management. Junior managers who are proactively tight on cost are learning good habits for the future, ones that will bring them recognition and advance their climb up the organizational chart.
Senior managers promote people who make tough decisions themselves and take full responsibility for those decisions. They advance people who come up with solutions, not problems. Too many junior managers take a long time to get to that coming-of-age realization. They prefer cozy after-work drinks with their teams, telling their staff that it's the boss making nasty decisions about not funding extra resources or getting rid of underperformers. They will still be having those cozy drinks in 10 years' time, when their take-it-on-the-chin cost-cutter colleague is in the boardroom.
And cost management is also not an issue only for the functions of finance, production control or customer call centers. The HR department, formerly full of personnel careerists who "just love working with people", is now staffed with hard-nosed cost managers whose task is to help manage that most difficult category, people cost. Marketing departments no longer think that all problems could be solved by doubling the ad spend, they think about how to get much higher returns from fewer marketing dollars. Even investment bankers and sales reps are getting cost conscious about expenses.
Cost Management - How?
Traditional cost control systems tend to be based on the preservation of the status quo and the ways of performing existing activities are not reviewed. The emphasis is on cost containment rather than cost reduction. Cost management focuses on cost reduction and continuous improvement and change rather than cost containment. While most Companies start thinking of Cost Management during not so good times, but prudence demands that it should becomes an integral part of a company's efficient function during good times too.
Cost management is a powerful tool that can be of immense practical use in profit planning decisions. Cost management techniques are an important part of doing business in today's difficult economic situation. They help in assessing and improving the operations and finances of a business. Companies are always trying to look for ways to reduce costs and improve efficiency. While it seems like a fairly simple concept, not all businesses are able to attain their cost management targets. However, with a properly planned expenditure program, any business should be able to stick to the budget and even save some money along the way. The following suggested measures can be adopted as a part of organizations' cost management program:
Reduce Unnecessary Expenditures
First of all, it is necessary to maintain an updated record of the company's gross earnings and expenditures. By looking at the actual amount of money coming into the business' coffers, as well as the money being spent for the various needs of each department, it would be much easier to zero in on the health of the finances. To improve the financial condition of the business, either the revenues have to be increased or the costs have to be decreased. It's usually easier to reduce costs, so the first things to address would be looking for unnecessary expenditures, and cut these from the allocation.
Conduct Cost-Benefit Analysis
When running a new project or trying to effect changes to an existing one, it is necessary to do a quantified and objective evaluation of the entire activity. Each project would cost money, but also brings in potential benefits. In this regard, a cost benefit analysis would come in handy when deciding whether to start a big activity, or whether to continue or stop a big project. Most management planning groups use the simple technique called the SWOT analysis. This literally spells out as "strengths," "weaknesses," "opportunities," and "threats." Another important consideration is the economic evaluation, which determines the net effect of any project or undertaking from the point of view of all the stakeholders involved.
Verify Inventory Management System
In case of manufacturing organizations which purchases raw materials from suppliers, or outsources certain services from other companies, it is necessary to reassess how efficient the business is in utilizing these services. For instance, the business might be able to look for better supply contracts that would result in cheaper costs, but be sure it doesn't sacrifice quality of own output.
Audit the usage of Resources
Another way of reducing expenses is by auditing the use of the company's resources. Sadly, much is lost due to fraudulent use of company assets. For instance, some employees might be abusing their expense accounts, or some might be using the company credit card for unauthorized personal expenses. Some might be doing fraudulent claims on the company's health insurance policies. A simple audit of all these simple activities would help business managers reduce loss from fraud.
Cost management is an essential aspect of any business, both in times of economic boom and difficulty. Any profit-seeking enterprise stands to gain when costs are reduced and managed properly, with the aim of positively contributing to the bottom-line.
Managing costs in Global Meltdown
We are passing through a global economic crisis of very severe proportions. In this situation managing the business has become more demanding as market conditions are tough or uncertain. Difficulty is faced in planning the things because of the uncertainties that business is facing with respect to product prices, sales volumes, cash flows, recoveries as well as the number and volume of orders. Pace of the business is slowing and there is a lot of news about an economic recession. It becomes very essential under these conditions to hold the nerves and desist from looking at solutions which may prove to be worse than the problem itself. Therefore, correct identification of the problem which caused the meltdown and the path to be taken to fix it and prevent the possibility of recurrence of such problems in future becomes absolutely essential.
If necessity is the mother of invention, then recession is surely the mother of cost reduction. In fact, some of the most significant developments in cost reduction methodologies for organizations have often been driven by major global or industry downturns. The manufacturing sector has responded to a series of recessions with the adoption of new strategies for improved quality while 'doing more with less.' These strategies included quality circles in the 1980s, followed by total quality management (TQM) and total preventative manufacturing (TPM) in the early 1990s. More inclusive approaches such as lean manufacturing and Six Sigma were more widely implemented in the late 1990s and early 2000s.
Each new approach to cost reduction is based on lessons learned in the past. At the same time, each approach must be forward-looking, developing new perspectives that reflect current market conditions and, more specifically, recent changes in cost structures. Therefore, companies should ask how the current economic downturn will shape today's cost reduction approaches and how they can move beyond the tried and tested methods of previous eras. The first step is to understand how this recession is different from previous downturns. We also need to consider what elements of a company's cost structure have changed the most since the last recession.
A new challenge
Today's crisis has already passed a number of dismal milestones, including being classified by many industry commentators as the worst economic decline since the Great Depression of the 1930s and a sharp decrease in stock market performance. Along with the sheer magnitude of these market declines, the crisis is unprecedented because companies are now focused not only on cost reduction - the norm during any recession - but also on cash release. Indeed, a recent KPMG survey of business leaders found that 85 percent of respondents saw cash management as a key priority, and 24 percent identified it as their top priority for 2009.
This recession is also unprecedented because cost reduction is being driven to a much greater degree by external factors. Previous cost reduction responses have been focused internally, improving performance from a historical base and showing sustained benefit. Insofar as companies could show these improvements, they were given the benefit of the doubt. Today, however, a widespread concern around financial viability has prompted many financial institutions to retreat into the most conservative assessment methods of their clients.
Accordingly, companies must now prove their cost control credentials in relation to their peers. 'Better than last year' is no longer the appropriate reference point. Companies must show that they compare favorably to their entire sector, with little heed given to companies that claim to operate under special circumstances.
In terms of cost structures, we can identify two significant changes that have emerged since the last recession. The first and most obvious change is that many of the cost reduction opportunities amenable to TQM, lean, and Six Sigma strategies have already been captured. Nowhere is this truer than in the manufacturing sector, where previously defined levels of manufacturing excellence have now become the norm. As a result, the hunt is on for new fields of opportunity, which increasingly appear at the boundaries between processes and departments.
As an example, many manufacturing companies lack sufficient integration between their supply chain and finance functions. Most manufacturers recognize that determining true customer profitability by taking into account cost drivers such as credit and logistics is simply good practice. However, 14 percent of companies in the KPMG International survey still report poor visibility of cash flows - often caused by inadequate linkages between operations planning and the treasury function.
The second change in cost structures involves the extent to which cost drivers now lie outside the formal boundaries of the company.
Volatile commodity prices and exchange rates, increased financial pressures on suppliers and market downturns have all introduced uncertainties that require a different set of tools for cost reduction. Understanding the true costs of low-cost sourcing, and weighing supply chain risk into your equations is a difficult but necessary discipline that should be mastered.
In short, the current recession demands much more than a traditional, inward-facing perspective. In fact, we can say that cost performance is relevant only in relation to an external viewpoint, and companies should become masters of their external cost drivers as much as they have mastered their internal ones.
A unique approach
Here are some cost management strategies that can be adopted by any business organization in recessionary times, which will definitely act as solutions for survival and success of the business:
Gear up Cost Reduction Process: Speed up the cost reduction against external comparators. Whether looking at stock turns, IT costs, HR, back office, finance or engineering, the ultimate test is not the internal ability to change, but the ability to beat the peers. By using both internal and external databases of cost comparators, one can better determine the real position.
Plan the Future: Always plan for both immediate cost reduction and for ongoing cost management. Many companies started their cost campaigns well before the onset of the economic downturn. The intention was not only to survive the downturn but also to be well positioned when the economy recovers. Sustainability should be the watchword of the activities.
Focus the Cost Control Activities: Adopt an aggressive but focused stance towards the costs. Look at the costs from a variety of angles and leave no stone unturned. It requires understanding of how external factors influence the business and its cost structure and focusing on those costs within the organizations' control.
Understand the Ability: Try to assess the business capabilities in terms of both time and skills. Few companies in manufacturing have ignored cost in the past, and yet the conversion rate of projected savings into actual savings typically stands at less than 40 percent. Think about the organization's ability to deliver a concentrated bout of cost reduction using combined approaches of accounting and subject matter expertise.
Avoid Wastages: Cost reduction starts by avoiding unnecessary costs. With the increased levels of business failure, supply chains have never been more fragile. Balancing the pursuit of cost reduction with an appropriate appetite for risk is critical. Conduct an audit of your resources and eliminate the wastages, if any. Simple things can save money and help the environment (paper recycling, stopping excess energy use, better control of consumables, stationery etc).
Cost Management - Key to Survival and Success
As the global economy stares in the face of recession, business organizations are trying to keep their heads above water. Industries all over the world are affected due to Global recession. The business environment is changed. Companies today face the challenge of increasing competition, rising cost. Demand instability and input price instability is raising concern to the industries. The dilemma is trying to control costs while also ensuring they remain competitive. Organizations realized that, to remain in the business, they must improve their own business practices and procedures, where the cost reduction program of the organization is very important. Companies that are losing money need to increase profits and should need to cut expenses. The cost reduction exercise may vary from industry to industry but the methodology of cost reduction does not vary. Some of the known techniques are Value Engineering, direct cost control, indirect cost control, waste elimination etc.
Globalization has made cost effectiveness in product delivery an absolute "must" for staying competitive in the global market. Overall cost leadership is today the buzzword without which survival and growth are perceived to be virtually impossible. In today's time of rapid technological change, tough global and domestic competition, total cost management is central to sustained corporate profitability and competitiveness. The management mantra today is conquer your costs, before they conquer you. The cost leadership strategy does not mean compromise on either quality or technology or product differentiation. Low costs are no advantage, if the customers are not willing to buy the product of low cost firm. Cost management has to be driven with customer as the focus.
The survival triplet today for any company is how to manage its product/service cost, quality, and performance. The customers are continuously demanding high quality and better performance products/services and at the same time, they want the prices to fall. The shareholders are also demanding a required rate of return on their investment with the company. Thus, cost has become a residual. The challenge is being able to manufacture or provide service within the stipulated cost framework. Thus, cost management has to be an ongoing continuous improvement program.
Today the market leaders are even pursuing cost-reduction as a strategic imperative. They want to stay ahead of the market by continuously widening the gap between their cost and that of their competitors and re-deploy the resources for profitable growth. In the current global meltdown, whatever may be the company's condition, it's a good idea to take stock of the business to figure out what one can do now to make his company healthy even if business gets worse. It is possible to survive the downturn more easily if one masters the techniques of effective cost management.
Cost Management Strategies for Sustainability and Growth
Conventional cost management usually follows the formula that when the economy deteriorates, companies should reduce costs to become profitable again. This cut-and-slash approach to cost management can lead to a loss of customers and market share, unsustainable turnover of experienced staff, and inefficiencies in the long term.
In comparison, strategic cost management holds that cost should not be reduced at the expense of business strategy and that costs must be managed for economic value. Costs should not be managed in isolation to each other, but always with regards to the value generated from the costs spent. The strategic cost management suggests that:
Step 1: Determine Value and Cost Drivers
First, determine the drivers of the existing cost base. Managers must understand value and cost drivers, and how they interact. A value driver is "anything within or outside the business, in the present or future that directly or indirectly leads to cash inflow generation". A cost driver has an almost identical definition, except in this case it is anything that generates cash outflow, instead of inflow.
By viewing costs and their associated contribution to value this way, companies can assess which costs lead to the highest value-add, and which ones are superfluous to the business. Value drivers derive from value to the customer for example improved product quality, or delivered value such as an increase in sales or an improvement in corporate image and brand value. Cost drivers must consider the entire life cycle model of costs, both short and long-term.
For example, a supermarket looking to reduce costs might be considering buying a fleet of new trolleys. Under conventional cost management, this may mean reducing the number of trolleys ordered from 5,000 to 2,000 and ordering from a cheaper supplier for a lower price. Strategic cost management takes into account the fact that customers may become disgruntled with the lack of trolleys available and the poor quality of a trolley's deviating wheel. These customers may then decide to shop elsewhere, making the savings counterproductive.
Step 2: Strategic Cost Analysis
To cut costs strategically, consider the two following questions:
What is the 80/20 split? Determine which 20 per cent of costs offer 80 per cent of the opportunities for major reduction in costs.
Which costs can be re-engineered? Some costs are easier to reduce than others. Behavioral cost drivers, for example, the amount of stationery used by employees, is more easily modified than structural cost drivers such as size of the factory used in production.
Step 3: Strategic costs reduction
These two steps allow businesses to reduce costs without damaging long-term strategic prospects:
a) Protect key value drivers and optimize long-term value.
Many businesses fall back on cost cutting in advertising, training and recruitment in the economic downturn, simply because these expenses are not structural cost drivers and are easy to turn on and off. However, taking a longer term view of costs and strategy, a business should also consider how lessened market visibility, unskilled staff and insufficient employees will impact the company in the future.
For example, American Express, Kellogg's and Diageo are companies that are maintaining or increasing their marketing spend in the recession because effective marketing is one of the key value drivers for these organizations ("Best Global Brands," Burt Helm, Business Week, September 2008).
b) Review and reduce costs.
Based on the cost analysis performed in Step 2, change, remove or reduce activities that do not contribute to an increase in sales, cash flow or opportunities for the business. Some examples are finding a cheaper supplier without compromising on quality or stopping direct mail marketing if there have been no sales generated from this method. Businesses must think outside the box to find ways of decreasing costs while also improving long term sustainability in line with strategic goals.
Tesco, the global supermarket chain, is reducing store extensions. The company is reported to be spending £1 billion less in the 2009/10 financial year compared to last year. Instead, the supermarket is focusing on stocking more non-food items on its shelves as profit margins are higher on these products compared to from its food categories. ("Three Cost-Cutting Traps and How to Avoid Them," Stuart Cross, blogs.bnet.co.uk, September 2008). In another bid to reduce costs, Tesco has also virtualised their real time sales system, which has saved the company a significant amount of electricity costs and supports Tesco's long term strategic goal of reducing CO2 emissions ("Tesco Increases Virtualisation to Cut Costs," Angelica Mari, computing.co.uk, March 2009).
In today's era organizations are trying their hard to reduce their costs. Ascertaining cost and finding out the ways to reduce it has become the main issue for the organizations stepping into the uncertain environment of 21st century. By following certain steps and framework of cost management, an organization can effectively and efficiently implement some good strategies related to reduction of costs and that in turn will decide the future competitive advantage of the companies trying to maintain their market share and brand image in the tough competitive markets.
No doubt, the organizations that have a strategy to manage cost effectively through a downturn will be better placed to take advantage of the opportunities available today, and will emerge from the bad times re-energized and fit for the future. But here the question is that, is cost management critical only during troubled times like recession? Is cost management less important during periods of high growth and prosperity? It has been seen that business leaders tend to focus on revenue growth during normal and boom times and allow costs to inflate beyond necessity. Then, during slowdown period and recession they switch back focus to cost management by letting loose the bean-counters, who then begin to cut back costs on an ad hoc and opportunistic basis. This is a wrong approach to cost management. In a business organization, which intends to run efficiently, costs need to be managed (not necessarily reduced) all the time - both prosperous and troubled times - and not with a stop-start approach. It cannot allow unhealthy accumulation of fat in any segment or type of cost at any time.