Is slashing your budgets really the hero move, or could it be the silent killer in disguise?

You can’t read or watch the news without it mentioning the villain of inflation or its ugly sidekick, interest rates and organisations of all shapes and sizes left as the unfortunate victims.

In this environment, cutting costs isn’t just a nice thing to do; it’s the essential weapon in the CFO’s toolkit.

But as in all great thrillers, it is more complex than it first seems. Cutting costs is not easy, and mistakes are easy to make.

Here are five challenges to avoid when cutting costs.

1. The Savings Riddle

The first challenge is defining cost savings.

When is a cost increase not a cost increase? 

When it’s a saving…

Some organisations count a saving as not doing something.

Seven Types of Cost-Saving

a) Avoidance / Budget Saving

If you don’t spend the money you planned to spend this year, then it’s classed as a saving. But of course, if you spend the money next year instead of this and it costs 10% more, is it really a saving?

b) Technical Savings

Of course, there are also technological advances—the cost stays broadly the same, but you get more for your money (regardless of whether you need the extra functionality!).

With new technology, you can do more, saving time or avoiding costs elsewhere.

c) Inflationary Savings

In an inflationary market, if the Procurement team has done a stellar job and secured the following order of goods or services at the same price as they are now, then the cost avoided is considered a saving. The procurement team has managed to secure an increase lower than the cost the market has raised. For example, if the market increases by 10%, but we’ve only paid 5% more, the difference is counted as a saving.

d) Historical savings 

If you are paying less than you did last year due to volume discounts (or threshold spending being achieved), suppliers may be able to unlock discounts, reducing costs.

(You may want to legitimately book the savings outlined in b-d above to measure the Procurement team’s effectiveness)

e) Savings against the business case

A business case often includes an estimate of the project’s costs. However, this is put together without firm pricing from the market. By issuing an RFP (Request For Pricing / Proposal), the overall costs may be lower than the amount specified in the business case. Many organisations count this as a saving.

In reality, it could equally be that the business case was overly pessimistic.

f) Ratio savings 

These are relative reductions in the proportion of a product’s cost. For example, if something was 10% of the cost of a product last year but is now 8%, then the reduction is often referred to as a saving. However, it could be that other costs have increased at a higher percentage.

h) Efficiency savings 

If the processes have been changed, requiring a lower usage of something, you may need to buy less, which results in savings.

However, even if the costs are lower than you expected, a cost increase still reduces your margin if you can’t increase your revenue.)

So, as we’ve seen, defining what a saving is isn’t quite as simple as it might first seem.

Takeaway:

Defining a cost saving is more challenging than it might first appear.

Here’s what to do to keep and keep things simple:

Take a purist view of defining and measuring a saving.

I like to look at a saving as:

The cost of the item is a proportion of revenue or the proportion to the cost of sales.

If the proportion of cost decreases, it’s a cost-saving or cost reduction. If it’s not, then it’s a cost increase.

2. The Buy-in Battle

Getting buy-in is one of the biggest challenges for a CFO or finance leader looking to cut costs.

For most managers, cost discipline is as appealing as an ice bath: good for you but unpleasant.

I have been in executive team meetings where the executives violently agree that costs must come down, and everyone agrees, “We need to make savings.”

Yet, they can’t immediately think of a single area for saving as things are already pretty lean.

Like some executive game of wink murder, each executive secretly points at the other, highlighting the savings that could be made in their colleague’s area (too many salespeople, too many corporate people, blah..blah…blah).

However, reducing costs in their area would be difficult as things are already lean. Leaving the meeting with the promise to look for savings, but finding them would be a challenge.

Then, in any follow-up meeting, they reveal that they are already a couple down because Janet and John left last month, and they haven’t been replaced.

Quite often in these meetings, Executives will explain why, instead of cutting costs, they should increase spending in their areas….

For the CFO, getting agreement on actions for savings is virtually impossible.

And before you know where you are, everyone hates you.

Most management teams will reluctantly agree that costs need to be cut occasionally. However, the most successful and competitive organisations have embedded cost discipline as a way of doing business.

Takeaway:

The best way to ensure buy-in for a cost-saving programme is to get everyone on the same page that cost-saving measures are required by using forecasting and benchmarking, highlighting cost trends and recommending courses of action.

It’s often seen as an unexpected shock when you need to cut costs. Don’t let this happen.

Aligning your Executive team’s sights on the financial target can turn your cost-cutting crusade from an Equaliser-style solo mission into an Avengers-level campaign.

However, building a culture of cost discipline in your organisation is the most effective way of ensuring long-term financial sustainability.

3. The short-term vs long-term conundrum

Desperate times often call for despair measures.

In desperation, you look for easy ways to manage costs.

The allure of the quick fix – slashing travel, hiring freezes, even axing the sacred office coffee or taking back the mobile phone, is very tempting.

But, it’s like losing weight by starving yourself – effective in the short term but excruciating.

These “financial diets” can lead to a cultural and Intellectual famine, sending your star players packing. Remember, trimming the workforce isn’t just about numbers; it’s a saga filled with emotional and financial backlash.

One of the biggest challenges of cost saving is the temptation to focus on immediate savings without considering the long-term consequences.

While trimming the workforce or making drastic changes may provide quick cost savings, they can also have detrimental effects in the long run.

Immediate savings may initially appear attractive, but they can often be short-lived. Without careful analysis and consideration of the potential implications, these savings may vanish quickly and result in significant financial strain.

The real kicker?

Those immediate savings might be a mirage.

With savings disappearing faster than your morning espresso.

This costs you money and damages your organisation’s financial health in the long run, often by much more than you saved.

Equally, the decision to cut the workforce is traumatic not only for those who leave the organisation but also for those left behind, as survivor guilt kicks in.

Savings can disappear quickly.

A 10% reduction in employee numbers leads to a similar decrease in payroll costs.

With market rate pay adjustments, this can be eaten away in less than three years.

Rehiring after realising that dismissal was a mistake can significantly increase costs. According to data from Gallup Consulting, replacing an employee can cost twice as much as keeping them.

It is far better to be strategic about reducing and removing long-term costs from your organisation.

However, those costs can take longer to remove from the organisation as they require changes to processes, ways of working or systems.

Why do we need so many people?

In one organisation, I was in conversation with a leader who highlighted an area employing many people as ripe for reducing costs.

That’s the wrong answer to the wrong question.

The right question to ask is why does that area need so many people to do the work?

Understanding what’s driving the need is critical to reducing costs.

Without reducing the workload or reengineering the processes, you aren’t going to make a substantial impact in creating sustainable savings.

Focus on long-term sustainability.

As research firm Gartner said, it’s no wonder why two out of every five businesses mess up regarding cost reduction.

 Cost reduction must be a formal, well-planned-out strategy within the organisation that emphasises long-term sustainability and has the support of upper management and internal stakeholders. Changing spending policies “on the spot” rarely generates the desired results. If you have to implement short-term cost-saving measures to address a known problem, you’ve failed in your forecasting.

Cost-cutting measures, such as workforce reductions, can result in emotional and financial backlash.

Downsizing can create a hostile work environment, decreasing morale, productivity, and employee engagement. Additionally, the economic repercussions of severance packages, recruitment, and training new employees can outweigh the immediate cost savings.

Survivor guilt is another emotional challenge that arises when some employees are let go while others remain. The survivors may feel a sense of guilt and unease, which can affect their motivation and loyalty to the organisation.

Takeaway:

If you have to implement short-term cost-saving measures to address a known problem, you’ve failed in your forecasting.

Short-term cost savings are for short-term, unexpected issues, not for things that have been known about for months.

4. Killing your darlings

Executive teams find it very difficult to kill off projects.

Especially ones that have already been started.

The problem is that executive teams often decide about projects in isolation from other work.

After all, business cases support a project to be initiated because it’s a good idea, so rarely do they include all the reasons you shouldn’t do it.

Each approved project is an excellent idea in its own right.

However, the implications of managing too many excellent and vital projects simultaneously can lead to complexity and increased costs.

I like to think of one of too many projects as one of Gordon Ramsay’s Kitchen nightmares:

Adding more chefs and dishes to the kitchen doesn’t make the dishes go out any quicker; the extra chefs will get in each other’s way, and you’ll quickly run out of sous chefs and pottery as they do more work.

Before you know where you are, you are taking on more “sous chefs” and “pot washers”, upgrading the size of the “kitchen bench” and buying more “stove tops”.

Because control spans have increased, you’ll need more managers and probably some form of quality assurance, too. You’ll also need more monitoring/reporting and more finance people. More people require more overhead, whether facilities, HR, or IT.

Have we increased the speed of flow?

Probably not.

Takeaway: 

As a CFO, giving an executive team an overview of what else is happening in the organisation will improve decision-making effectiveness enormously.

Each project may be a good idea, but it may need to be re-sequenced or reprioritised for something else.

Managing constraints is sometimes a good thing.

I remember a former CEO saying:

“You can’t always do more with less. Sometimes you just have to do less with less”.

5. Customer Conundrums and Competitive Capers

The assumption is that cost saving is done in a vacuum – considering the impact on the customer or end-user is vital, as well as the response your competition is likely to face.

It’s easy to say, “We won’t cut front-line costs”, but cutting “back office” costs will inevitably impact the front-line costs through slower system responses and smaller office accommodation in a less convenient location.

In New Zealand, many organisations advertise “New Zealand-based customer support” to differentiate themselves from the competition.

This leads to a related point: you shouldn’t cut costs in areas that add value to your customers.

You should manage your expenses carefully, but if it gives you a competitive advantage, you should keep doing it.

There’s the famous story about how United Airlines saved $100k a year by removing one olive from each salad.

It was an easy save, which nobody noticed.

Of course, they’d have saved $200k If they’d removed 2.

You might think you’re a cost-cutting ninja, reducing costs, hoping no one will notice, but customers are ninjas, too. Remove too much, and they notice…

There comes a point when cost-cutting is too extreme, so you must always consider the minimum viable offering/product—this might be based on your competition or market research.

Still, the important thing is that you aren’t out of whack with what you’re trying to do as an organisation and that savings support your organisation’s goals.

Takeaway:

Investing in assets that reduce variable costs is a sensible approach.

There’s a reason why aluminium and titanium are used so much in the aircraft industry – they are lighter and, as a result, need less fuel to carry around.

Pennies saved on large volumes of transactions, adding significant savings over time.

And Finally:

In this high-stakes game of financial Jenga, every move counts. But remember, in the rush to cut costs, don’t lose what makes your organisation shine. After all, it’s not just about surviving the fiscal storm – it’s about ensuring you’re in a solid position to thrive when you’ve passed through it.

Ready to navigate the cost-cutting maze with confidence? Let’s chart a course that protects your company’s future please get in touch.

Empower your financial strategy

For CFOs looking to expand their influence, the path forward involves embracing innovation, investing in personal and professional development, and fostering a culture of strategic thinking within their teams. The future belongs to those who can see beyond the numbers, and maybe I can help; please get in touch.