Good morning.
Trimming costs has been a priority for many CFOs this year. But companies may be sacrificing some of their most important investments in the process, according to experts.
"Cost Cutting That Makes You Stronger," a new report in Harvard Business Review, argues that trimming costs to drive short-term savings is a mistake. It states that when companies take a “one-off approach” to cost cutting, it’s ineffective.
Vinay Couto, a vice chair, and Paul Leinwand, a global managing director at Strategy&, PwC’s strategy consulting business, are the authors of the report. Couto and Leinwand explain that executives face a choice—cut costs the traditional way and risk making their organizations weaker, or do the hard work of rethinking the very basics of their business.
To learn more about companies that have successfully managed costs while still achieving growth, they conducted a study of the 1,500 largest global public companies, based on 2021 revenue.
The companies that fared the best in the long term took five critical steps: connected costs to outcomes; simplified radically; reimagined value chains digitally, in rapid sprints; and rethought what work the ecosystem should take on.
Based on the research, I asked Couto to point to specific areas they’ve found are best for cost cutting, and areas that should be avoided.
The right areas for cutbacks:
—Exiting unprofitable businesses and markets/countries
—Reducing redundant and non-value-added financial and business reporting
—Consolidating procurement spend with preferred vendors
—Cutting technology costs by eliminating redundant systems, consolidating software licenses, or switching to cloud-based solutions
—Reducing excess real estate capacity
—Cutting energy costs by investing in energy-efficient equipment
—Reducing excess seniority and hierarchy in the top three levels of the company
—Consolidating manufacturing plants
—Adopting new technologies to automate manual business processes, customer interaction processes, and business planning, reporting and analytical work
—Reducing unprofitable SKUs (analyzing the cost of carrying each inventory item) and customers
The wrong areas to cut, according to Couto.
Training and development: “Cutting budgets in this area prevents employees from acquiring new skills and adapting to changing business environments."
Employee benefits: "This can harm employee morale, decrease productivity, and lead to increased turnover. It can also make it more difficult to attract top talent in the future."
Research and development (R&D): "It might seem like an easy area to cut given that much of this expenditure is on long-term bets. Reducing investment in R&D can severely impact a company's long-term growth potential."
Customer service: “Cutting costs here can damage relationships with customers, impact customer retention rates, and erode customer loyalty.”
Marketing: “It is vital for attracting new customers, retaining existing ones, and maintaining brand awareness. Reducing marketing efforts can negatively impact sales and business growth.”
Maintenance and upgrades: “Deferring these costs can face increased costs in the long term. This could be due to equipment breakdowns, software vulnerabilities, or other operational inefficiencies that result from outdated technology or facilities.”
What about human capital? Is cutting headcount to drive short-term savings a potential pitfall?
“From a pure business perspective, if a company's survival is at stake, layoffs might be justified to ensure the company remains viable,” Leinwand explains. “If the alternative is bankruptcy, then layoffs could save the company and, by extension, the remaining jobs. And in some cases, especially in rapidly changing industries, companies might need to shed certain roles and hire for others to adapt to new market conditions."
“However, the decision to use layoffs to improve short-term profitability, especially when a company is not in financial distress, can be detrimental to long-term success,” Leinwand says.
What’s at stake is a loss of talent and institutional knowledge, along with lower morale and productivity, he says. “Future hiring costs could also be an issue,” Leinwand says.
You can read more here about Couto and Leinwand’s research and strategic planning.
Have a good weekend.
Sheryl Estrada
sheryl.estrada@fortune.com
