Cost Management

To Prosper, Spend for Growth and Cut Costs Too

Doing both results in significantly improved return on invested capital, Gartner advises.
David McCannMay 14, 2019

The best CFO approaches to cost management deliver up to a 7 percentage-point premium on return on invested capital, according to a Gartner study of the S&P Global 1200 companies.

The findings indicate that companies that spend for revenue growth while also proactively cutting costs — an approach Gartner calls “efficient growth” — significantly outperform those that focus mostly on high growth or reducing costs.

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Gartner calculated the companies’ return on invested capital minus their weighted average cost of capital from 2010 through 2017. The 61 companies identified as “efficient growth companies” experienced an average return of 5.4%. (Such companies were identified as those that consistently grew both top-line revenues and bottom-line profits over an extended period.)

A control group of 61 of those companies’ industry peers experienced an average return of -0.8%. For the entire sample, consisting of 1,141 companies, the return averaged -1.7%.

“Company costs have increased faster than revenue since 2013, creating a profitability gap that has not been filled even as earnings have improved from their 2014 slump,” said Jason Boldt, a director at Gartner. “The choices CFOs make about how to allocate resources to pursue growth and how to cut costs show quantifiable differences to returns on invested capital.”

He added that managing costs is a prevalent theme in recent earnings transcripts. While, on average, 81% of a company’s costs are defined by the industry they are in, according to the research, the remaining 19% are largely determined by executive decision-making.

“This is where high-performing CFOs — who deliver the best return on capital — are making their impact felt,” Boldt said.

The research showed four key “cost anchors” — or negative management behaviors that drag down earnings — that most companies suffered from.

Almost 9 in 10 (87%) of companies suffered from poor cost visibility and 89% from cost equivalence (the perception that all costs are the same), while 84% used outdated cost models and 90% were hampered by business resistance.

To overcome poor cost visibility, companies should employ multiple budget models that provide a more flexible approach for identifying good costs from bad, according to Gartner.

“A mix of rolling forecasts, driver-based budgeting, and zero-based budgeting provides CFOs with a clearer analysis of the relationship between costs and revenue,” the firm said.

As to the other cost anchors, to overcome cost equivalence Gartner advised that companies separate costs into transactional and value-add categories. They also could benefit from updating their cost model approach by using a service-based view of costs. And overcoming business resistance is a matter of helping business partners focus on controllable factors.

Raising “Cost Ladders”

Leading cost management executives also encourage four positive cost behaviors, or “cost ladders,” that contribute to positive shareholder return, according to Gartner.

However, the firm added, fewer than one in three companies studied exhibited any of the four behaviors:

Encouraging transformational bets. This involves mapping previous investments and clearly categorizing between transformational and iterative bets, Gartner said. By doing so, CFOs can better decide how to allocate funds to transformational bets that will have the most impact on achieving the company’s overall investment criteria.

Increasing cost agility. Cost management leaders employ “proof of concept” financing that investigates uncertain variables underpinning a growth investment’s chance of success, according to Gartner. If a proof of concept test reduces uncertainty, CFOs release funding to complete the growth investment. This uncertainty-reduction process gives management teams an edge on competitors by taking on risky growth bets with more confidence.

Detecting early cost warnings. Most companies don’t have a clear mechanism to flag when costs are likely to spiral out of control, Gartner observed. Cost leaders in this area operate from a forecast model that identifies cost headwinds and tailwinds on a quarterly basis, considering such factors as foreign exchange rates; selling, general and administrative costs; pricing; volume; and productivity.

Rapidly reallocating from losers. Reallocating funds from losing to winning projects can have a very positive effect on overall company performance. An in-progress initiative review can provide the data needed to make such decisions.

Evaluating projects that are in progress, based both on current performance and leading indicator trends, can help CFOs identify opportunities to provide additional capacity and funding to projects that are outperforming.