Reining in costs in a pandemic marketplace

The economic repercussions of the COVID-19 pandemic have forced boards of directors and executive leadership teams to make a meticulous assessment of all aspects of their business. The most successful ones have strategically contained their costs to ride out the rough waters of the past year.

Before COVID-19, many companies focused on revenues and market share, and paid less attention to cost containment or transformation. As the pandemic has lingered, they’ve been compelled to optimize their cost structures and deploy operating models that are not only sustainable but also agile and scalable for future growth. On the upside, such sustainable cost transformations have forced them to pay more attention to their core capabilities and their strategic priorities.

In pre-pandemic times, most organizations tended to apply an arbitrary percentage to their prior-year spend as a guideline for cutting costs in the current year. Such a doing-more-with-less approach typically resulted in budget overruns, demoralized staff, and quality issues. Companies need to be smarter. They should adopt a more analytical, zero-based approach to ensure cost-reduction programs are sustainable as well as strategic.

Make your business more attractive

Done well, sustainable cost transformation can help fund future investments, build organizational capabilities, and promote a culture focused on performance improvement. From a mergers and acquisitions perspective, the rollout of successful sustainable cost transformation programs makes assets more attractive to potential buyers—not only because the business is lean, but because it further demonstrates management’s credibility. During a sales process we recently observed, the management team identified and executed $15 million in annualized savings, which substantially increased the enterprise value on the sale.

Strategic and financial buyers place emphasis on a target’s costs to assess potential operational efficiencies and cost synergies. Typically, these potential buyers will analyze two to three years’ worth of a company’s expenses to better understand the organization’s fixed-versus-variable cost split, how the costs have changed relative to sales, and how the costs compare with those of industry peers. In addition to evaluating the operational costs, the buyers will look at potential capital expenditure costs that may be required in the near future to either maintain the level of performance or realize growth opportunities. These kinds of analytics are critical to helping boards of directors, management teams, and potential buyers thoroughly understand the company’s cost drivers and upsides.

Consider fixed and variable costs

It’s not uncommon for boards and executives to wonder where to start their analysis. A good place is to begin by breaking down costs between fixed and variable. As simple as it sounds, many organizations struggle with this. Then, they can further break down the difference between payroll and non-payroll costs. From that point, they should seek to understand what drives costs and look for opportunities to shift fixed costs to variable ones. They can then focus on reducing or eliminating variable costs.

Over the past 12 months, we’ve seen many clients use these analytics to become better positioned to ask themselves if they should shift their operating model, including whether they should consider outsourcing and/or hybrids.

This exercise can also be helpful in analyzing the right balance of physical as opposed to digital real-estate assets. Indeed, during COVID-19, many organizations shifted their operations from downtown locations to lower-cost areas. If many employees now work remotely and may continue to do so in future, downsizing a company’s physical location could lead to further cost reduction opportunities. Continuing to limit business travel and investing instead in technology to enhance digital communications—as many industries have come to accept as the norm—will lower ongoing costs and, as an indirect benefit, lower companies’ carbon footprints as well.

Investing in automation over physical assets, meanwhile, is the way forward for many companies. Automation is already shaping the way companies operate. It’s no longer the exception but the norm; stakeholders want companies to embrace technologies and data analytics to drive productivity, enhance operational excellence, and improve customer satisfaction for a competitive advantage.

Recognize that challenges remain

Company leaders should also consider how to avoid allowing certain costs to creep back into the business. Many have relied heavily on government relief programs during the pandemic, but this funding is not endless. Management teams should ensure costs to be incurred in the future are necessary to achieve the strategies they’ve set. Those costs that are deemed necessary should be optimized, achieved by streamlining and automating low-value activities or outsourcing an activity altogether.

While it’s not necessarily difficult to identify costs that can be cut and efficiency measures that can be adopted, the process can be expedited by bringing in a third party to independently review your company’s finances, gauge your profitability and viability, and can help advise you in making tough calls on matters such as staffing and potential spending. An outside advisor can also help businesses break down silos, which remains a challenge for many companies.

The key is to focus on the business as a whole, including where, how, and with whom it operates. Supply chains are more global than ever and geopolitical issues, like trade wars, can dramatically affect costs. Labour expenses can fluctuate depending on where staff is located. Undergoing strategic cost transformation is a big initiative, and requires looking at every aspect of your business. But, if selling the business is your main objective, it’s the only way to remain profitable and appealing to potential buyers.