Cost management is often the neglected stepchild of the finance chief’s office, often overlooked in favor of the more exciting tasks of finding new and innovative ways of growing existing markets or tapping into new ones. But while lower profile, managing costs, staying on budget, and making adjustments when appropriate are critical to every company’s long-term sustainability.
Despite cost management’s importance, CFOs face a big challenge when it comes to getting team support and buy-in. We have found that in the most successful companies, there are four key common attributes to achieving an effective cost management process.
Culture. “Company culture” isn’t just a ping-pong table in the break room, after-work happy hours, or wearing flip flops. The biggest cultural challenges at many companies are caused by, or fixed by, the culture that leadership employs. The red flags to listen for include: “we’ve always/never done it that way,” “finance handles that,” “we don’t really look at that,” and “this is what we are doing.”
Of course, there are many more things to watch for, but successful cost management needs to start at the top of the organization. For example, if the president likes to tinker or is obsessed with finding the next best thing at all costs, R&D spending likely will have consistent spending overruns. Similarly, if the executive team finds exceptions to T&E policies and often travels via first class or stays at five-star hotels, there will be a general lack of cost management embedded in the culture of the organization.
There must be buy-in from the executive team on down related to any cost management philosophies, and that team must “walk the talk.” Once that happens, then “cost champions” within the organization will emerge with greater buy-in. More importantly, they will drive creative, outside-the-box thinking to bring new cost management ideas to the table.
Budget. Once the culture is established, a framework for the company’s cost structure must be developed. There are many ways to budget — top down, bottom up, rolling budgets, set it and forget it, budgeting software, via a massive spreadsheet, and so on. There are pros and cons of each of these takes on the budget, but setting a budget and monitoring and responding to related variances is the foundation of cost management.
There are varying levels of budget management that can be effective. At a minimum, a monthly review should be performed by function/department where variances are discussed and corrective actions are pursued. The budget review process can also drive additional opportunities from the start of the year (e.g., material cost reduction from suppliers of X%), or improvements identified during the year (e.g., reduction of overtime of Y%). In addition to a monthly variance review protocol, a further step is to put in place spending (purchase order) approvals to ensure costs are contained within budget to prevent overruns in the first place.
KPIs. Once the budget is set, how do you prevent it from veering off course? While the budget will provide high-level direction as to where spending is tracking, it is often difficult to ascertain the status in a more real-time fashion. KPIs, or key performance indicators, can accomplish this advance look at “where the numbers will come in.”
In our experience, top-performing companies monitor processes and costs with KPIs, while only a portion of the non-top performers do so. KPIs are critical: as the management guru, Peter Drucker, said, “What gets measured, gets managed.” Think of these metrics in income statement categories. For example, KPIs could include metrics to lead to better cost improvement management, such as:
- Materials – purchase price variance, scrap, yield, cost per pound;
- Labor – productivity (hours per XYZ), headcount, overtime; and
- Overhead – downtime, direct labor to indirect labor ratio, savings goal.
Analyze and Adjust. The KPIs may keep you on track, but at the same time, it is still necessary to be able to identify and react to issues when necessary. The best cost analysts typically reside within the finance department, but budget variance analysis is often pushed off as being less important and too time consuming. This is one of the most important value-added functions where finance “pays for itself” but it has to be done efficiently to create actionable initiatives.
It is easy to get lost in the massive amounts of data that one can obtain from an ERP database, for example. Further, there is a tendency for finance to drive this analysis to a very high level of accuracy. While 100% accuracy is an honorable thing to shoot for, it takes significantly more time to accomplish that last 10% whereas the conclusion, or feedback, is typically no better. Most companies can benefit by working towards “directionally correct analysis” thereby “completing” more analyses. At that point, finance can be providing feedback to the organization and driving corrective actions or adjustments in spending to better manage costs
Integrating a KPI and analytically focused strategy into the company’s culture and DNA can move it successfully beyond simple enforcement and regulation, to advancing a shared priority across the enterprise. Once cost management is supported by a foundational budget, KPIs, and analytics, it can become a part of a company’s culture — beginning with leadership and moving throughout the organization. The results can be significant and will form the foundation of creative cost savings ideas that lead to ROI.
Brian Stewart is a Director with The Keystone Group, a management consulting firm. His areas of expertise include profitability and cash flow improvement; mergers and acquisitions; and financial and operational restructurings.