Expense Management

When Cost Cutting Gets Expensive

Restructuring charges are commonly 125% of the savings actually realized, which makes cost cutting a losing proposition.
Daniel Mahler and Greg PortellDecember 27, 2016

During periods of slow economic growth, companies instinctively move to curtail their costs, often via strategies shaped by the CFO. Yet many cost cutting programs actually cost the company money.

Daniel Mahler

Daniel Mahler

How? Serious efforts to shed costs require substantial investments, as evidenced by the cumulative $44 billion in restructuring charges reported by the Fortune 500 during their most recent fiscal year, per a scan we conducted in 2016.

Too often, these massive investments in cost cutting fail to deliver the intended result. Our analysis found that restructuring charges are commonly 125% of the savings actually realized, which makes cost cutting a losing proposition.

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There are instances when the ratios are actually far worse. We know of one consumer products company that invested $125 million in a cost cutting program that delivered just $20 million in cost savings. Compounding the problem, costs that were successfully taken out via cost cutting programs tend to creep back in before long, making the entire effort an expensive exercise in futility.

Greg Portell

Greg Portell

OpinionThe implications are staggering. In a persistently sluggish economy, companies that repeatedly but ineffectively cut costs can do serious harm to their bottom lines (146 of the Fortune 500 missed earnings estimates last year). Further, after diverting company resources to cost cutting, companies have less money and talent available to drive the top line. Our scan found that the Fortune 500 posted 0% cumulative revenue growth last year.

Kicking the Can

Look closely into why cost cutting gets expensive, and you often find that some components of the company’s strategy demand investments disproportionate to the attainable savings.

For example, a U.S. company shuttering a European manufacturing facility can incur significant social costs, particularly mandatory funding of pensions, that force it to take a huge cash charge right away. If the cost cutting strategy includes too many such components, the net impact on the bottom line can be the direct opposite of what management intended.

When management sees few options they like, they often make no decisions at all, in effect kicking the can of unnecessary costs down the road, thus perpetually limiting the company’s profitability potential.

Squeezing the Balloon

Another reason cost cutting programs underperform is that organizations are remarkably resourceful at shifting costs targeted in one area of the company into areas that are not being targeted, making cost reduction efforts about as effective as squeezing a balloon.

The challenge is particularly acute in matrix organizations, where management accountabilities and functional lines are blurry. Who owns the cost… The region? The brand? Your operations chief? In matrix organizations, costs tend to be more slippery as well as more mobile.

Uncounted Costs

Beyond their direct investments in cost cutting programs, companies always incur significant uncounted costs that clearly impact earnings performance, yet are not commonly included in the cost cutting equation.

Some of these uncounted costs are readily quantifiable. The next time you attend a meeting dedicated to cost cutting, for example, consider what the people around the table earn and how much of their time is being diverted to cost reduction efforts.

Taking a more expansive view, consider the internal churn caused by cost cutting projects and the resulting emotional strain on the organization. Management teams certainly know and acknowledge that cost cutting is distracting and stressful. Rarely, however, do they account for the resulting loss of productivity as a clear “cost of cost cutting.”

Nor do they weigh the opportunity costs incurred when companies divert talent from their regular roles to focus on cost cutting efforts. What goals might the company achieve if the same money and talent were aimed at other objectives? How much would those other achievements improve profitability?

Real Cost Cutting

In sum, many cost cutting programs would not stand up to the cost cutters’ own tests of what is worth doing. As CFO, you can help ensure that your company’s strategy includes these four keys to real cost cutting:

Differentiated initiatives. Before committing to any program, distinguish high leverage opportunities from cost cutting initiatives that will merely sap the company’s resources while yielding few or no net savings. If you fail to identify such high cost elements and account for their drag on your results, your overall cost cutting initiatives will not deliver the benefits to cover those expenses.

Shared accountability. Shared accountability can stop costs from merely shifting around from one part of the company to another, which defeats the whole purpose of cost cutting. Set a single, overarching cost reduction goal, then hold everyone mutually accountable for its fulfillment. If targeted costs cannot be eliminated in one part of the organization, the unmet share is not taken out of your program scope. Another part must make up the difference. Shared accountability replaces unproductive cost migration with cross-fertil­ization of creative problem-solving, aimed at achieving true cost reduction.

True cost-benefit analysis. Your cost cutting strategy should be based on at least a rough calculation of the costs the company will incur beyond restructuring charges and the direct costs of strategy execution. What does the company give up when people spend time on cost cutting programs rather than on their regular jobs? Are the targeted savings large enough to justify that trade off?

Bold action. False assumptions and compromised thinking often lead companies into year after year of serial cost cutting that actually costs the company money. Our research suggests it is far better to implement fewer, bigger programs. Fortune 500 companies that channeled their energies into a few highly ambitious and thoroughly integrated programs generated 78% market cap growth between 2010-2015, while companies pursuing more fragmented serial transformations achieved only 26% market cap growth over the same period.

Bold action still entails hard choices. But going big versus incremental generally works better, and it always sends the right message. A gradual, hesitant approach to cost cutting signals a company in decline. Big, bold action suggests that the company has taken charge of its own destiny.

Daniel Mahler is head of Americas and a partner in the New York office of A.T. Kearney, the global strategy and management consulting firm. Greg Portell is lead partner in A.T. Kearney’s consumer and retail practice, Americas Region.