We are living in an unprecedented era. The COVID-19 pandemic has forced many companies to rethink their liquidity risk, resulting in massive layoffs in an attempt to stay afloat. However, should it really take an adverse event to focus on cutting costs? Looking back, it’s likely that companies could have avoided massive layoffs if they had put an emphasis on creating and maintaining an efficient cost structure. So where does the problem lie, and how can companies improve operational costs and efficiency?
Optimize the Strategic Planning Phase
Typically, a company’s earnings are closely aligned with revenue. But any company should consider the impact on earnings if they also added a strong focus on improving the efficient use of capital and optimizing cash flow.
At the beginning of each operating year, a company’s executive team executes a strategic planning process that outlines the company’s goals / earnings for the upcoming year, as well as the next three to five years. When the business environment is conducive for growth, the focus tends to be on increasing revenue with less emphasis on optimizing the cost structure. This, in turn, may create supply chain inefficiencies, unbalanced labor productivity and sub-par inventory management.
Companies tend to set goals without mitigating risk and scenario analysis, such as decrease in planned revenue, increase in supplier costs, macroeconomic changes, etc. To alleviate earnings loss from a downturn, processes need to be built that enable a firm to respond efficiently.
Improve Operational Costs
To improve operational costs, define a process that measures the return value of every dollar spent. Here are a few items worth consideration:
- Break Down of Fixed vs. Variable Costs: Understand the fixed cost structure, including contracts, and then increase / decrease variable costs as a function of change in sales dollars and/or units.
- Headcount ROI: Align roles and responsibilities with strategic goals and measure return on investment. This will provide clear metrics to measure employee performance, decrease ambiguity and increase accountability. (Learn more in our blog: “5 Keys to Successful Headcount Planning“.)
- Capital Investment: Define capital investment strategy, including metrics, such as hurdle rate / Internal rate of return (IRR) and continuously measure outcome to ensure that goals are realized.
- Invest in Data / Analytical Capabilities: Build a robust demand planning process and measure cost throughout the supply chain. It is critical to identify and understand the starting baseline in order to improve that process.
Having worked as both an employee and a consultant, I have come to admire the freedom and the focused approach of a consultant. Companies often undertake cost improvement initiatives that do not deliver the desired goals due to personal interests or biases, lack of knowledge of industry best practices, and over-stretched employees concurrently working on their regular jobs.
Because cost optimization initiatives invariably create friction, they are best handled firmly, yet delicately, and without fear of repercussions. Consultants are integral in bringing leadership, breaking down barriers, implementing changes (process and/or systems), possessing cutting-edge knowledge and focusing on results.
If you’re facing adversity, it may be more prudent to bring an outside perspective to shake the trees and implement process improvements or new processes. Every downturn is an opportunity to get leaner and be prepared for upcoming challenges.
Skimming? Here’s a summary.
A company looking to proactively improve operations can weather the storm and streamline costs by:
- Incorporating various scenarios into strategic planning
- Aligning headcount with strategic goals and creating accountability
- Building infrastructure / analytical capabilities
- Measuring every data point in the supply chain
- Investing in learning and implementing industry best practices
- Creating an internal culture where everyone understands the value of every dollar saved
Efficient growth requires discipline and creates a snowball effect on a company’s earnings. It tremendously improves a company’s ability to handle adversity. Problems are easier to identify and alternative solutions and practices are even faster to implement.
Don’t wait for the next crisis or pandemic to improve business processes. Proactively plan for business disruptions and economic changes. As the saying goes, “Fortune favors the prepared mind.”
More on Business Stabilization and Contingency Planning
If you’d like to learn more about how to improve operational costs, and as you build strategies for post-pandemic, download our guide to business stabilization:
About the Author
Prashant has over 15 years of finance and accounting experience. Having worked in private equity as well as a variety of other industries, he has years of experience in dissecting financial statements to understand the key performance drivers and increase revenue and profitability. He has led finance and accounting at various startups, implemented and streamlined processes and financial systems. Prashant holds a Bachelor in Mechanical Engineering, Masters in Industrial Engineering from Ohio State University, MBA from University of California-Berkeley and CPA (Inactive) from the State of Pennsylvania.