As the grey storm clouds of a global economic recession make their slow progress from the East, smarter organisations will already be formulating plans and strategies to combat its implications. Taking steps before a downturn, in the ‘good times’, can help avoid the sort of reactive and damaging decisions many will make when finally forced to do so. It is these reactive and forced decisions that often cause lasting damage to a company’s reputation and can impact its operational effectiveness and financial results for some years.
Having been involved in many transformations and restructuring programmes I have seen a number of approaches for dealing with income shortfalls. A classic mistake that most organisations will make when under pressure is to issue an edict to all budget holders instructing that they cut costs by a set percentage, perhaps 5% or 10%, or in the most severe cases 20% to 30%. On paper it works. The budget is slashed by the desired amount, operating revenues and costs fall into line and all is well with the world.
But is it?
From an accounting perspective, on the ‘plus side’, an organisation will take a one-off hit for restructuring costs but in theory will receive the benefits of a reduction in the overall recurring payroll operating cost. Discounted to present value the net of the one-off cost and ongoing savings should create, or should I say ‘protect’, overall shareholder value. So financially it seems to work but it is at the operational level that we often start to see problems, and hidden costs.
If there has been a structural change in market conditions you have a good argument for suggesting that work has effectively been eliminated and that the restructuring initiative is simply an exercise in balancing the cost base with declining revenues. Work previously required is no longer needed so we need fewer people. A cyclical change in the market which drives revenues lower creates a different kind of challenge. In this scenario you may still wish to maintain an operating capability but at the same time address a short term need to reduce the cost of the payroll.
It tends to be the cyclical changes in conditions where the issues arise. Many organisations will not distinguish between the two situations and will apply the same solution, a uniform % reduction in the budget. If the expectation is that conditions will improve over a two or three year period most organisations will expect their operational functions to maintain their capability but with less staff to do the work. The work has not gone away, it’s simply a case of there being fewer people to do it.
The pattern is always the same in these situations. Budget holders try to shift work around to other functions, work does not get completed or if it does its quality or timeliness suffers. Ultimately, it will impact on the service provided to customers.
It is vital therefore to rationalise a cost cutting exercise. A 10% or 20% reduction in headcount will indeed save ‘hard’ costs but it will likely impact in other ways. It may not be immediate but a poorly executed cost reduction initiative could ultimately impact revenue generation, the transmission mechanism being poor customer service. Operational managers may lay the blame on the cost reduction exercise but drops in revenues 18 or 24 months after the initiative will rarely get much of a hearing as a significant cause.
To cut costs sustainably and to minimise impacts of revenue generation it is essential to create a plan that allows the business to maintain its capability and service quality. The plan should manifests itself as a series of method improvements. These method improvements are designed to either eliminate work or ensure that it can be undertaken with fewer resources. Method improvements could include withdrawing from supporting certain markets. Quitting a market will obviously eliminate the need to support work in that area; in other words work is eliminated. Process improvements ensure that work is undertaken more effectively and efficiently – more work is undertaken by the same or fewer people. Technology can often be deployed to automate work previously undertaken manually. Organisational restructuring does not of itself save costs unless it is associated with another improvement initiative such as the creation of a shared service centre or perhaps an outsource arrangement. A new organisation structure is an output of a considered cost reduction plan; the elimination of work and improvement in the way it is carried out has allowed the organisation to administer itself with fewer managers and staff.
Closely associated with an effective cost reduction plan is some consideration of the impact on customer service. Organisations suffering from a major change in its markets may well be prepared to make some decisions about the service levels it wants to provide in the future. In this case if the method improvements do not in aggregate add up to the required cost reduction then a discussion on service levels must be had in order to address the gap. Though unpalatable, an exercise to define service levels across the operational functions should be undertaken so that senior management can take appropriate actions. Thus the plan for both a specific function and the business as a whole may well consist of a suite of method improvements and possibly an acceptance that certain functions will no longer be able to provide a level of service previously delivered.
Reducing costs is always a challenge. However, it is far easier and far more sensible to undertake a review of the operational cost base before a recession arrives than afterwards. From the perspective of early 2016 we are already being warned by international financial institutions, the BIS and IMF amongst others, about the impacts of a deflationary wave sweeping across the world. Another recession in North America and Europe may not yet be at our door but the leading indicators and forecasts are not encouraging. Smarter organisations ought to be undertaking strategic reviews of their operations today rather than in 2017. Will yours be one of them?