Finance strategists optimize costs to guard profits
Amid a slowing of the economy fueled by inflation, rising interest rates and the effects of the war in Ukraine, CFOs are looking to cost-control measures to help them maintain profitability.
Given the economic outlook over the next six months, CFOs ranked cost optimization as the most important area of focus in Grant Thornton LLP's Q2 2022 CFO survey. Cost optimization, cited by 27% of respondents as the top focus, outpaced important areas such as liquidity, access to capital and cybersecurity among finance leaders’ priorities.
Controlling costs might not be easy with labor, fuel and supply chain challenges all demanding dollars that may not be easy to cut, even as interest rate hikes raise the cost of capital.
Just 57% of CFOs surveyed said they are confident about controlling costs, even though 71% are confident in customer demand. That’s why many finance leaders are getting inventive and keeping in mind that cost control doesn’t always need to be accomplished through deep cuts.
“People are anticipating getting through this without too significant a cut in any one area,” said Robert Schwartz, Grant Thornton Principal and National Performance Improvement Leader. Their hopes may be falsely placed in a soft landing for the economy.
Sometimes CFOs are controlling costs by passing them on to customers. As shipping prices rose, one of Schwartz’s clients elected to add a line item to their invoices, directly billing customers for freight costs in an attempt to at least partially recover costs related to a specific customer. There was great concern among some employees at the company about alienating customers by asking them to pay for this additional line item.
So, the company polled its customers to better understand potential adoption risks associated with added freight costs.
“Customers literally said, ‘We were wondering when you were going to start charging for freight — what took so long?’” Schwartz said.
Although other strategies can help control costs, deeper cuts may soon be on the table for many companies. Often, the most immediate, short-term lever for cost reductions is labor, but Schwartz said he hasn’t seen many job cuts in the market yet, nor does he necessarily anticipate such cuts.
Labor remains a mixed bag for business leaders, depending on the company. In their zeal to stay ahead of the pandemic-fueled labor shortage, some companies may have overhired, and they could see opportunities to scale back. Other companies remain short on labor and couldn’t possibly entertain cuts. In prior recessionary markets, temporary labor cuts have usually been a good indicator of later permanent job reductions.
Meanwhile, anyone considering job cuts in this environment should be aware that some employers who cut jobs at the start of the pandemic suffered reputational damage in a labor market whose transparency has grown thanks to Glassdoor and other information-sharing sites. Some employers who made early-pandemic cuts had trouble hiring later during the labor shortage that emerged.
Other strategies for cost control may include:
- Cutting travel expenditures, which have rebounded since the beginning of the COVID-19 pandemic. Travel is the area most prominently cited by finance leaders as an area for reduced investment in the coming year. Travel was the top weighted choice for cuts in Grant Thornton’s Q2 2022 CFO survey at 29%, more than twice as high as any other expense category.
- Reducing investment in long-term strategic priorities, particularly as borrowing costs rise along with interest rates. Many businesses have expanded debt in recent years as they sought ways to grow, partly because interest rates were low. CFOs may be more conservative now with expensive, long-term initiatives.
- Outsourcing — though employers have learned the risks associated with offshoring labor during the COVID-19 pandemic and associated global supply chain upheaval of the past few years. Outsourcing computer hosting services, data storage and other commoditized services might make sense, but Schwartz said business systems that are customer-facing should generally remain in-house. “I typically advise clients, ‘You want to own processes and systems that differentiate your business and products from those of your competitors,’” he said.
- Closing unprofitable locations — a course of action some retailers and distributors are pursuing, according to Schwartz. He cites Massachusetts Institute of Technology Senior Lecturer Jonathan Byrnes’s premise that 40% of businesses are unprofitable as described in his book Islands of Profit in a Sea of Red Ink. In a retail chain, unprofitable locations become a target for cuts when they are a drag on overall performance and locations that turn large profits.
Virtually every client Schwartz encounters has an opportunity to improve profitability by 25%, but many clients choose not to pursue that lofty number. Some say it would be too much work. Some say it can be a distraction from their overall growth strategy. But that potential exists.
According to Schwartz, “25% of profitability in most businesses is locked up in inefficiencies that can be reversed with proper attention and discipline. The greatest challenge is getting leaders to focus on continuously improving businesses that are already meeting shareholder expectations and not simply accepting ‘good is good enough.’”
Some of those inefficiencies can be addressed by looking for cuts in any area where costs are growing disproportionately with revenue and peers in the same industry. Under current economic conditions, a combination of cost cuts, passing on costs to customers and other cost-control strategies can be key elements in the drive for continued profitability expansion.