Simplified Cost Structuring Spurs ‘Efficient Growth’

Companies are well-served by playing in fewer industries, entering fewer geographical markets, and having simpler product portfolios than peer firms.
David McCannDecember 3, 2019
Simplified Cost Structuring Spurs ‘Efficient Growth’

The largest companies in the world are experiencing a rate of growth in costs that Gartner calls “untenable.”

Specifically, from 2014 through 2017, the S&P Global 1,200 firms saw their compound annual growth rate (CAGR) of costs increase 1.8 times as much as their revenue CAGR, Gartner says in a recent report.

By comparison, during the years immediately following the financial crisis, 2010 through 2013, the CAGR of costs barely outpaced that of revenue — by only 1.05 times.

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So, what now? According to Gartner, new economic and competitive factors are emerging that CFOs say are rapidly influencing how their organizations plan to make substantial changes to their cost structures. Some of these factors:

  • Industry transformation is driving up competition and supplier pricing power.
  • Tariffs and geopolitical issues are increasing the prices of inputs, intermediary goods, and freight costs.
  • Customers are demanding customized products and services and are more sophisticated buyers with more information and omnichannel purchasing options.
  • New technologies on the cusp of broad adoption — e.g., machine learning, industrial and software robotics, driverless trucks — are resetting the base requirements for efficiency.
Efficient Growth

A small minority — just 5% — of the Global 1,200 companies fall into a category that Gartner calls “efficient growth leaders.” These companies meet three criteria:

  1. Long-term revenue growth — top quartile among industry peers in eight-year revenue CAGR.
  2. Long-term cost reduction — top quartile among industry peers in eight-year total cost reduction.
  3. Short-term revenue and margin expansion — top quartile among industry peers in the number of years simultaneously expanding revenue and EBIT (earnings before interest and taxes) margins.

So few companies qualify as efficient growth leaders because “operating cost productivity is especially difficult to achieve under … high-growth conditions,” Gartner says.

CFOs at efficient growth companies approach growth from a different starting point than peers, according to the report. Instead of focusing on growth and figuring out cost performance later, they pursue growth from the starting point of cost. In so doing, they differentiate themselves from competitors in three significantly significant ways, as detailed below.

Focused Growth Bets

Efficient growth companies concentrate growth in fewer industries — 18% fewer than their peers.

At an average company, processes are set up to encourage leaders to diversify and chase adjacent opportunities. For example, “a CFO might oversee a series of bolt-on acquisitions or pursue investment in a completely different part of the value chain under the premise that diversified growth will strengthen the path to top-line expansion,” Gartner writes.

However, the report notes, entering a new industry requires significant investment in fixed costs in order to compete

“Our analysis shows 81% of cost structure is determined by the industry itself, and the rest is attributable to cost decisions under management’s control,” Gartner says. “Managing fixed costs in a way that protects profitable growth … becomes incredibly complex as companies hold more than four or five industries in their portfolios.”

Efficient growth companies focus on a limited number of industries where they can maintain a high degree of learning, develop proprietary technology, and make growth investments that extend and protect their competitive advantage.

Simple Product and Service Portfolios

Efficient growth companies have 24% fewer lines of business than peer companies, according to Gartner’s analysis. This enables them to capture market share and spread fixed costs over more units. The fixed-cost approach, combined with a variable cost advantage (nine percentage points lower cost of goods sold), “means any marginal top-line expansion drives down average total costs.”

Gartner adds that functional leaders at such companies also benefit from a simpler product and service portfolio.

“It is much easier for a finance team, marketing team, or technology function to support a simpler product and service mix,” the report says. “Instead of managing the complexity of thousands of SKUs, for example, functional leaders can focus on driving better pricing and planning activities to stay nimble and competitive.”

Dense Operating and Customer Footprints

Efficient growth companies concentrate 20% more revenue in their largest geographic segment. “Not only do their CFOs focus on where they operate geographically, they also make smart bets about the best geographies in which to acquire and protect customer relationships,” Gartner writes.

Protected customer relationships allow efficient growth companies to focus on making the customer experience as valuable as possible.

When this is executed correctly, “the pain of searching for and switching to another provider is so high that customers are deterred from leaving,” the report says. It also allows the CFO to spend extra time with customers, which Gartner research has found to be “a hallmark behavior” of effective CFOs.

“The world is growing more globalized than ever,” Gartner observes, “but the importance of achieving scale through smart localization — in industries, product and service categories, and geographies — has never been higher.”

Overall, the research reveals that efficient growth companies focus on “building scale, not scope, in their cost structures.” This earns them a six-percentage-point return on invested capital premium over scope-additive competitors, according to the report.