VideoThere are tightly run ships, and then there is Apache Corp.
For every dollar of operating revenue it generated in 1999, this $2 billion (revenue) Houston oil and gas exploration and production company spent a mere 33.1 cents on operating costs, including selling, general, and administrative (SG&A) expenses. Excluding a handful of specialty financial services firms, this made Apache the leanest operator by far in CFO magazine's seventh annual Cost Management Survey (formerly the SG&A Survey).
Riding the crest of the longest economic expansion in U.S. history, one might expect relatively few companies to share Apache's focus on cost control. Yet in surveying the largest companies whose stocks are publicly traded in the United States (those with revenue of at least $750 million per year in each of the past four years), CFO and Exult Process Intelligence Center (now Hackett Collaborative Learning) found that the median company improved its costs-to-revenue ratio by 64 basis points from 1996 through 1999. That ratio is reflected in what the survey calls a company's cost management index, or CMI. It is calculated by adding a company's cost of goods sold (COGS) to its SG&A expenses, and dividing the sum by the company's operating revenue.
To be sure, this improvement reflects more than across-the-board belt-tightening of the sort that was popular just a few years ago, when cost-cutting CEOs like "Chainsaw Al" Dunlap were corporate folk heroes and many managers and investors alike seemed to believe that the only good cost was a cut cost. That platitude was debunked in 1998, when it became clear that Dunlap's closely watched effort to turn around Sunbeam Corp. collapsed in a heap of losses and led to his ouster. Today, companies are much more careful to weigh not only the risks of haphazard spending, but also the potential rewards of judicious investing.
A New Model for Cost Efficiency
All kinds of companies are investing in technology and changing their organizations in order to reduce operating costs as a percentage of sales, according to John Engquist, a director at Exult Process Intelligence Center, which crunched the numbers for this year's survey and helped to create the CMI metric. "It used to be that SG&A was just burdensome overhead; you just sliced it and sliced it and sliced it. Today, the goal is to figure out where to strategically invest to create value."
Consider the example of Cisco Systems Inc. In 1999, Cisco spent 36.7 cents on SG&A expenses for every dollar of operating revenue it generated, exceeding the median for its industry group by 340 basis points. Yet the $18.9 billion company was a veritable miser when it came to COGS, with that figure equaling just 30.9 percent of operating revenue in 1999, way below the industry median of 51.8 percent. Combine Cisco's SG&A and cost-of-sales numbers over the four years from 1996 through 1999, and the company ends up with an industry-leading CMI of 66.5 percent versus an industry median of 82.9 percent.
Cisco vice president and controller Dennis Powell says the real message behind those numbers — and a big key to the company's success — becomes clear only after you break out the company's sales costs from its general and administrative expenses. "We think our G&A costs are low at around 3 percent [of revenue], which is pretty good for any industry," says Powell. "But the bottom-line metric against which we measure ourselves is customer satisfaction. For that reason, we put a lot more cost into the sales area to make sure we've got a high level of customer satisfaction."
Even Cisco's low COGS number reflects a growth-oriented business strategy, because while it has been investing in its sales operations, the company has also been investing in Web-enabled technologies that further refine its well-known outsourced- manufacturing model. Cisco calculates that it saved just under $1 billion this year as a result of Web initiatives.
"When an order comes in, our vendors can see it as if they were part of Cisco," says Powell. "Over the past several years, we figure this has allowed them to reduce inventories by about 45 percent. Also, we're able to do integrated testing of all our products over the Web before they ship, and still allow our partners to ship and build about 60 percent of our products without physically touching them ourselves."
On the service side of the business, Powell says, 70 percent of the company's support calls are now handled over the Web rather than via a telephone call. Cisco believes this development has reduced its incoming telephone calls by 75,000 per month. Customers also download about 90 percent of the software they need from Cisco, eliminating physical shipments of software. "For us, it's not so much an issue of cutting costs, but of figuring out how productive we can be with the people we have," concludes Powell. "We are very passionate about leveraging technology to improve productivity."
Much the same strategy is employed by $17.6 billion Sun Microsystems Inc. The company ranked a close second to $88 billion IBM Corp. in the "computer systems and peripherals" industry group, posting a four-year CMI of 81.4 percent versus an industry median of 90.2 percent. But don't credit that performance to low SG&A expenses; like Cisco, the percentage of Sun's costs accounted for by those activities actually exceeds the industry norm by a wide margin.
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