Managing costs

Objective

As a business leader, you will inevitably have some financial responsibility. You will be expected to demonstrate financial management – in particular the ability to deliver your team’s planned performance within budget. You must aim to apply six principles.

• Planning – you must be clear about your strategic and operational priorities for expenditure.
• Contingency – your financial planning should include provision for the unexpected.
• Support – you will need (unless you are an accountant) strong financial support in thinking through planning and ongoing financial issues.
• Authority – you must have and work within a clear structure (sometimes referred to as ‘delegation of authority’) regarding who is allowed to commit to what expenditure to what levels.
• Reporting – financial reporting should be thorough, regular and transparent so that you understand ongoing performance exactly.
• Action – you must use financial information to take corrective action to deliver planned performance.

Your objective is to regard the management of cost as a key tool for delivering performance in a planned and systematic manner.

Context

The management of cost is inextricably linked to organisation structure. In essence there are a number of factors which frame your ability to influence cost:

• the balance in your business between fixed and variable costs, as the former will be harder and take longer to influence and change;
• who has operational responsibility for actions driving cost – you may be on the receiving end of costs which you don’t control;
• who has operational responsibility for supplier management – the existence or otherwise of purchasing functions can impact the effectiveness of cost management and responsibility for it in your overall organisation structure – if for example you operate in a matrix, responsibilities for some costs may be shared or the subject of regular internal negotiation;
• the existence and effectiveness of control and approval mechanisms – for example, do cost management guidelines exist which are enforced?
• leaders’ attitudes to cost – do the prime leaders of your business exemplify an attitude of careful management of resources?

Although cost management is ultimately an accounting issue, the way in which it is managed overall says a great deal about the cultural state of your organisation.

Challenge

In my experience, an organisation’s ability to manage costs is largely constrained by two factors.

• Fear – changing planned spending usually means confronting someone else’s budget, and this can be both political (you may be seen to be making a choice) and sensitive (no one likes to lose out, especially when cherished pet projects are at stake). Reducing costs may challenge strategic objectives, levels of employment, the organisation structure and existing relationships with internal and external suppliers.
• Inflexibility – businesses tend to assume, over time, accepted ways of working, and cultural standards that may not be verbalised. This is what I have described elsewhere as the ‘we have always done things this way’ mentality. Planning to reduce costs may challenge deeply held norms. The challenge to culture becomes at least as significant as the challenge to cost.

Your role as a leader is to be brave and flexible – to deny the status quo any assumed legitimacy, to be prepared to ask uncomfortable questions, to challenge legacy assumptions and, if anything, to champion the countercultural.

Success

Finance and accounting can be complex and technical. Your success in this area will depend on you taking a fundamentally practical approach, in which you are seen to demonstrate not only the importance of cost management but your personal involvement in it.

• Financial planning – you must be deeply involved in all the financial planning of your business unit (especially at each strategy, budget and quarterly review phase), and be familiar with all the key financial drivers. You cannot leave finance to financial staff.
• Finance relationship – your relationship with finance staff (your finance director if you have one) is critical because you will depend on their astuteness and insight. This is one relationship you must work on intensively – you need complete confidence in the reliability of this colleague.
• Materiality – you must be familiar enough with the costs for which you are responsible to know what is material (i.e. to know which elements make a difference).
• Contingency planning – never plan your business area without a view of what to do if things go unexpectedly; always know in advance the corrective actions you might need to take.
• Prioritisation – have a clear idea of what matters and what your priorities are so that, bluntly, you know what you are prepared to sacrifice.
• Control and delegation – have a system of controls in place so that everyone who works for you knows what they can and can’t commit to; and which ensures that you are involved in all the financial decisions you need to be.
• Reporting – have detailed cost reporting (at least on a monthly basis) at the level of detail you require, and one which passes a materiality test (i.e. you track cost at the level required for effective decision-making).
• Public reporting – ensure that financial reporting is transparent among your immediate colleagues so that there is a clear understanding of shared responsibility and accountability.
• Procurement – use the skills and techniques of procurement professionals to analyse and reduce cost systematically where the scale of cost merits it.
• Outsourcing and insourcing – have an open mind about the merits of insourcing; sometimes the continuous use of external resources can be more expensive than dedicated internal resources. Don’t set outsourcing up as a cost-saving inevitability.
• Next-stage reductions – as you task your team to think about opportunities to reduce cost, begin to think about the stage after next; the next areas for examination that your colleagues are unaware of.
• Process reviews – encourage all your staff to analyse their business functions as a series of processes to identify process improvements that are capable of delivering economies.
• Activity reviews – further challenge your staff to identify activities that can be eliminated completely.
• Technology reviews – identify all manual tasks and seek to replace them with cheaper automated alternatives where it is plausible.
• Evolutionary thinking – stand back from all the activity described above and think about how your business area is evolving. Consider structural changes that could further drive down costs.

The length and depth of this series of actions itself indicates the complexity of managing cost. It requires a wide range of financial and personal skills, an acute sensitivity to the cultural impact of cost management, a simultaneously panoramic and detailed view of your business area, and an ability to analyse the immediate, the medium term and the long term.

Pitfalls

The main risk in financial and cost management leadership is to fail to give yourself room to manoeuvre, especially if you:

• plan with no contingency;
• make too many commitments and leave the ‘cupboard bare’;
• have too loose control over what is spent;
• have poor financial reporting and transparency about expenditure;
• can’t think flexibly about different ways to act.

So the moral as far as cost management is concerned is to expect the unexpected and plan for it!

Leaders’ checklist

• Make a point of learning the ‘pillars’ of finance in an operational business – profit and loss, balance sheet and cash flow.
• Understand the three types of cost you may be responsible for, and how they affect the business differently.
• Never forget that ‘cash is king’.
• Don’t be afraid to take on the fear and to tackle the inertia which may inhibit an honest appraisal of opportunities to reduce costs.
• Be aware of how complex the management of cost is – how multi-dimensional it is.
• Prioritise a good relationship with your finance ‘person’ – this is worth its weight in gold.
• Remember at all times the mantra of procurement professionals – businesses can always save 5 to 10 per cent.