VideoIt's not for lack of trying.
Faced with continued economic turmoil and uncertain revenue streams, companies everywhere are scrambling to cut costs as much as they can. But because of the speed and ferocity of this particular downturn relative to the free spending of the peak boom years, those efforts are still not reflected in their cost-to-revenue ratios.
"The economic downturn caught many companies flat-footed," says Jon Scheumann, a director with business-process consulting firm Gunn Partners, which teamed with CFO to produce the ninth annual Cost Management Survey. "What we are seeing in the cost management index [CMI] is a byproduct of how hard it is to change your cost structure."
In this year's survey (using 2001 data), the median company CMI — calculated by adding cost of goods sold (COGS) to selling, general, and administrative (SG&A) expenses and dividing by operating revenues — was 87 percent, compared with 85.3 percent in 2000. And during a five-year span (1997-2001), median cost-to-revenue ratios increased (read: worsened) by 79 basis points.
"You are seeing companies really get focused on cost, beginning in the last half of 2001," says Scheumann. But even firms that recognized the severity of the downturn didn't take the first steps — layoffs, restructurings — until late in the year and into 2002, he says. Consequently, the benefits won't begin to be seen until next year's survey, and the payback in terms of real structural change won't be evident "until late in 2003." The reason? Companies often lack the flexibility to cut costs, especially SG&A costs, in concert with declining revenues, he explains. "Their efforts always lag the economic cycle."
Still, within the 50 industries surveyed, several firms excelled at cost control. Not surprisingly, the leanest operators make it a priority at every point in the business cycle. Take Kinder Morgan Energy Partners, a pipeline limited partnership with a five-year CMI of 43.0 compared with a median in the oil and gas (pipelines) category of 79.4. Says C. Park Shaper, CFO of the Houston-based firm, "The bottom line is that we are very cheap." Regardless of the economic environment, he notes, "no one flies first class, we don't advertise, and we don't have excessive executive pay."
In fact, Shaper notes, the company's CEO and vice chairman receive $1 each in annual salary and nothing in bonuses. Instead, as partners, they receive a share of all profits on a quarterly basis — a requirement that demands a stable cash flow. "The partnership structure provides a lot of discipline," says Shaper. So does the budget process, which permits only costs "integral to the operation of our pipelines." He is so confident of Kinder's ability to keep those costs in check that he publishes the annual budget on the company's Web site.
At Six Flags Inc., CFO James Dannhauser also points to the budget process as key. There, the five-month effort is focused on "comparing costs on a park-to-park basis," looking for best practices that can be leveraged companywide. With 39 parks, he says, realizing economies of scale is a major priority for group purchases. "And it's not just with, say, food," he says, explaining that economies are also sought in "what's typically seen as fixed costs, such as insurance."
The results can be seen in Six Flags's CMI, which was 27.5 in 2001 (the industry median: 70.7), meaning that for every dollar of operating revenue generated, the company spent only 27.5 cents on operating costs. Dannhauser notes that, going forward, he can't control how the economy will affect top-line growth — through the first nine months of '02, for example, park attendance was down 7.4 percent. Nonetheless, he expects Six Flags's CMI to remain steady. "Being vigorous on costs," he says, "is one element we can control."
Scheumann expects cost control to remain a rallying cry in 2003. But it will still be some time before the benefits show up in the CMI. Next year, "expect it to level off or slightly decrease," he says. "Realistically, we will have 18 to 24 months of lag time." Keep squeezing.
Lori Calabro is a deputy editor of CFO.
Methodology Review
For the ninth annual Cost Management Survey, CFO magazine again teamed with Gunn Partners, an Exult company. This year's survey sample is based on North American publicly traded companies that reported at least $750 million in revenue annually for the years 1997 through 2001. More than 1,000 companies were grouped into 50 major industry groups. Company data was sourced in a standardized format from Thomson Financial, part of The Thomson Corp.
Data was analyzed for consistency and comparability across companies and industries. Metrics were calculated to assess cost efficiency and performance. This year, like last, the perspective was broadened to look at both COGS and SG&A (before depreciation and amortization). For financial firms, noninterest expense was used.
Candidates were ranked by their five-year cost management index (CMI), which equals COGS plus SG&A, divided by operating revenue.
Tightening Up: Leading Cost Containers in 50 Industries, 1997-2001.
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