Resizing a Business in a Downturn
Tactical or structural cost reduction?
The recession and credit crisis are causing precipitous declines in consumer and business demand. In response to declining sales, many companies need to resize their business and reduce costs in order to maintain acceptable margins – or even just to stay afloat. The main question is how far to go. Should you focus on a tactical approach that delivers incremental savings in a relatively short time? Or a structural approach that delivers results that are larger and more sustainable?
Here’s the debate:
|Trim costs through tactical improvements
Focus on areas such as discretionary spending, SG&A and incremental process improvement
|Tactical improvements such as hiring freezes, reduced travel and training, and across-the-board budget cuts deliver fast results.||True. But there’s a good chance most of the easy improvements have already been done. What do you do next?|
|Across-the-board reductions are the fairest way to cut costs.||These types of cost reduction programs invariably cut too much in some areas and not enough in others. A more thoughtful approach can better position you to cut fat without cutting muscle. It can also deliver greater savings.|
|The company is already managing costs through continuous improvement. Isn’t that enough?||Continuous improvement is a good way to boost operating efficiency; however, because it focuses on detailed improvements, it often overlooks many of the biggest savings opportunities that span organizational boundaries. Continuous improvement is certainly worth doing, but it’s not a cure-all.|
|Focus on structural cost reduction
Pursue sustainable improvements such as streamlined infrastructure, reduced product complexity and new business models
|In a deep recession, companies need big savings. Attacking structural cost is the only way to resize the business and achieve step-change improvements in underlying costs.||Unless you manage structural costs aggressively — from the top-down — the results may not show up fast enough.|
|Focusing on structural costs addresses areas that a tactical approach overlooks.||A structural approach requires new cost reduction initiatives. Where will you find the time and money? Also, are you willing to take on the sacred cows?|
|Structural improvements such as reducing product complexity, rationalizing the customer base, exiting geographies and changing the operating model can make your company more agile and responsive, not just more cost efficient.||That’s true in theory. But such benefits only matter if you survive the short term. You need improvement now – not a year from now. Tactical improvements should be job one.|
Omar Aguilar, Principal, Deloitte Consulting LLP
The current economic crisis is shaping up to be worse than expected. As a result, many companies are finding they must become more aggressive about reducing costs and resizing the business to operate efficiently at reduced volume. Tactical improvements alone are unlikely to deliver the necessary savings.
To achieve the required reductions, most companies must apply a structural approach that focuses greater attention on strategic improvements such as streamlining their infrastructure, adjusting their service delivery model and redesigning their business model. These types of improvements can deliver cost savings that are larger and more sustainable. And the good news is that a structural approach doesn’t have to take a long time. If done right, it can start delivering results just as quickly as a more tactical approach. Here are some tips for getting started:
Know where you stand. Many companies are in worse shape than they think. For example, debt covenants often have strict requirements for cash flow and profitability, which means that even a company that is handling the downturn gracefully may find its existing loans suddenly withdrawn — leaving the business desperately short of cash.
Dig deeper. Companies must accept the fact that their initial 10-20 percent cost reduction targets may not be sufficient to weather the storm. In many cases, a total reduction of 30-50 percent could be needed. The sooner a company faces reality, the faster it can start seeing results – and the greater its chances for survival and competitive advantage.
Look at everything. In a deep and prolonged recession, traditional belt-tightening activities such as hiring freezes, expense deferrals, reduced travel and training and across-the-board budget cuts won’t be good enough. Companies must look at structural improvements such as direct spend and COGS (Cost of Goods Sold) reduction, infrastructure optimization and financial restructuring. They must also give more attention to their balance sheet and cash flow.
Focus on major cost drivers. When resizing your business, focus on the structural drivers that drive complexity and cost. Customers, product mix and number of SKUs (Stock Keeping Unit), geographic footprint and physical assets can all play a significant role in determining a company’s structural costs. Rethink what you can afford for the current and expected market conditions, while preserving your core business and capabilities.
Shed non-core operations. As the economy contracts, many companies are finding they have become too large and diversified for their own good. Divestitures and portfolio rebalancing are critical tools in the resizing arsenal. However, it’s important to consider the impact that a spin-off or carve-out might have on sales, the supply chain and supporting business functions.
Take a holistic approach. Different cost reduction initiatives have different timelines and produce different results. By applying a comprehensive and integrated approach, companies can better manage the overall effort to achieve both immediate savings and large-scale improvement.
A structural approach to cost reduction can better position a company to protect its margins, capture market share and capitalize on opportunities such as bargain-priced acquisitions. It can also free up resources to invest in new products and services, marketing and advertising. These activities can help a company survive the downturn and get a jump on competitors when the economy turns around.
A view from the life sciences sector
Sanjay Behl, Principal, Deloitte Consulting LLP
Life sciences companies are wrestling with a wide range of challenges, including major product failures, slowing sales, price pressure and weak product pipelines. In addition, many pharmaceuticals companies face expiring patents that in the near future could significantly reduce their sales. These challenges have caused most life sciences companies to underperform the S&P 500 over the last five years.
Typical responses include mergers and acquisitions, as well as licensing to strengthen product pipelines. However, cost reduction must also play a key role. An effective cost reduction program can improve earnings and share value while the company waits for future revenue to kick in. It can also boost long-term margins and improve competitiveness.
Recently, large pharmaceutical companies have announced layoffs in SG&A, R&D and manufacturing as part of an ongoing effort to keep costs in line with revenue. They are also significantly reducing costs in other areas. Some leading medical device companies have taken similar steps. Yet, many other companies in the sector have yet to take action. Here’s our advice:
Get started. In this troubled economy, no company is immune from cost pressure. If you haven’t put a cost reduction plan in place, now is the time to start. Create a balanced mix of near-term tactical opportunities and longer-term structural opportunities that give you the flexibility to respond to an uncertain future.
Examine the core. Many companies are understandably reluctant to cut costs in fundamental areas such as sales, manufacturing and R&D. However, we believe there are ways to reduce costs without damaging the core business. Companies should examine their operating models and identify opportunities to reduce costs for general and administrative activities and support functions. For example, establishing a shared services model for support activities — such as sales operations or research operations — can save money while at the same time improving service levels by creating a critical mass of capabilities and greater cost flexibility. Also, it may be possible to reduce service levels in ancillary areas such as market research, analytics, creative services and alliance management without significantly undermining the company’s overall performance.
Aggressively reduce spending. Negotiate better prices on external marketing spend. Reduce expenses in areas that lack a clear ROI, such as grants, investigator initiated trials and field medical team activity. Work with contract manufacturers to secure better service levels and eliminate minimum order quantities that limit your flexibility. Reduce the scale and scope of existing R&D projects, keeping projects alive but eliminating non-essential activities.
Think big. In some cases, structural change might be the best way to do more with less. For example, some companies are reducing the size of their sales staff — which is a huge expense — while at the same time investing to make the sales staff more effective through improved targeting, a stronger contracting strategy and higher requirements for education and experience.
Actions like these can help companies compete successfully in the rapidly changing life sciences marketplace and position them to thrive when the economy turns around.
A view from the oil and gas sector
Sampat Prakash, Principal, Deloitte Consulting LLP
The sharp decline in oil and gas prices is having a varied impact on companies in the sector. Major oil producers – flush with cash – continue to focus on the long term. Their major strategic initiatives typically take years or decades to complete, which requires them to stay insulated from short-term market fluctuations. Like most businesses, these companies are taking steps to reduce discretionary expenses such as travel and training. However, their cut backs are mostly an effort to stay lean and mean -- not a matter of survival.
It’s a different story for many smaller companies such as oil field service providers, onshore drilling companies and some independent oil producers. These businesses are already feeling the squeeze from reduced production volumes and need to reduce costs quickly. To date, most of their efforts have focused on tactical areas that provide immediate savings with a focus on cash flow improvements. However, it’s likely that cuts in these areas alone won’t be sufficient to weather the storm.
To increase their chances for survival, companies at risk must look for strategic and structural improvements that offer cost savings that are both substantial and sustainable. These changes generally take longer than tactical improvements, so it’s important to get started early. Some of the companies we are working with are not waiting for their tactical savings to dry up before expanding the search to include strategic opportunities. They are anticipating the need, and have started looking now.
A view from the telecommunications sector
Michal Locker, Director, Deloitte Consulting LLP
For several months many thought the telecommunications sector would withstand the current economic crisis; however, economic conditions are starting to affect telecom service providers and the companies that supply their equipment. Telcos have recently seen consumer demand for broadband leveling off, residential customers ditching traditional wireline phones for wireless service or cheaper options from cable and VoIP (Voice Over Internet Protocol) providers and enterprise demand falling as companies continue to reduce their work forces. In addition, telcos are delaying some capital investments, which is having a significant carry-over effect on equipment providers.
While the downturn impact on telcos is not expected to be severe, they cannot stand still. Consumers continue to shift toward increasingly complex products such as IPTV, internet services and mobile data — an ongoing trend that drives operational costs through the roof.
- Customer support costs are increasing due to the higher call volumes and longer call times required to handle complex products.
- Network costs are rising as carriers deploy and maintain new infrastructure to support advanced services.
- Customer acquisition and retention costs are likely to increase due to market saturation and competition.
In order to maintain and improve their margins in this challenging environment, telcos must find new ways to optimize operations and reduce costs. Here are two primary ways to do this:
- Improve the efficiency of operational areas such as call centers, field sales, retail stores, installation and repair. This includes optimizing the order-to-cash process. Based on our experience, these types of improvements can deliver savings in the range of 22 to 35 percent.
- Optimize business support areas such as Marketing, Product Management, Finance, Human Resources, Benefits, Sourcing & Procurement and Information Technology, which can result, based on our experience, in savings of 11 to 24 percent.
By focusing on both types of areas, telcos can reduce their short-term costs while at the same time strengthening their long-term competitive position.
On the equipment side, although many providers have already announced significant lay-offs, they should continue to focus on improving efficiency and reducing external spending — particularly in light of increasing demand from very low cost overseas providers. However, they should not do this in a vacuum. Every equipment manufacturer must take a critical look at its product portfolio and R&D investments and ensure both are aligned with its long-term strategy. This focus — combined with a continued, relentless focus on costs — will better position equipment providers to emerge from the current crisis stronger, even if smaller.
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