The next disruption: Cost Control
A perfect storm of macroeconomic impacts from the pandemic could challenge the ambition and agility of businesses in the ‘next normal’. Rising inflation, interest, and taxes combined with shortages in supply chains and labor markets is creating a potential tsunami of cost control issues not seen since the late 1970’s. Deferred or delayed efforts to mature and modernize the finance function could leave many businesses unprepared to adequately respond to the next round of disruptions with actionable decision analytics for pricing, planning, and profitability.
As the country recovers from the pandemic crisis, policy makers are facing a delicate balance of economic factors that will give the modern macroeconomic playbook its greatest challenge since the last hyper-inflationary period experienced nearly 50 years ago. This generation of business leaders has not faced the tough decisions required to protect profits while facing the headwinds of excessive inflation. Navigating the inflationary storm will require a new level of insights on the economics of their business to pinpoint the path forward for profitable growth.
A dismal forecast
The ‘great resignation’ saw an historic 19 million Americans quit their jobs between April and August of 2021, nearly 12 percent of the workforce. Lack of workers and rising turnover has created a war for talent, driving wage growth into double digits. Covid caused individuals to reevaluate their careers, work-life balance, and curbed their spending habits. For the broader economy the lack of workers and consistent turnover is slowing recovery, contributing to rising prices and extending supply chain disruptions.
GDP growth is settling back into the pre-covid range, after a major bounce back from the depths of the global shutdown. The previous views that post Covid increases in inflation rates are ‘transitory’, related to temporary shortages and delays, are now shifting to real concern. Optimism in the macro economic recovery now should be tempered by the gap between wage growth and GDP growth. This pattern of wage growth out pacing productivity growth for a sustained period is eerily similar to ‘the great inflation’ period of the 70’s. The longer this gap continues, the more concerned we should all be.
Now inflation is disrupting our economic recovery and challenging the ambitions and agility of businesses to generate profitable growth as the pandemic concerns pass. The combination of labor shortages, supply chain disruptions, and loss of productivity during the pandemic are now showing up in inflationary prices to meet the demand of society’s desire to return to normalcy. Just when it looked like the sun was shining on our economic rebound, the recession avoided during the pandemic by historic government stimulus now looms in the shadows.
The modern macroeconomic playbook calls for raising interest rates to slow inflation. The Federal Reserve now views inflation as its biggest threat, already planning multiple interest rate hikes in 2022, taking the Fed Funds rate from .25% to over 2.0% by the end of 2022. However, the Feds playbook for inflationary defense has not faced challenges like this, and the playbook may be limited by the negative impacts on historic levels of US government debt. As interest rates rise, the debt service wallet share of the government budget grows, leaving two options for congress, reduce spending in other areas or raise taxes. The Fed’s ability to navigate a safe landing for the US economy this year will be complex as they are already behind the inflation curve and overreach could cause even more economic disruption.
But as the world waits to see how these factors play out in the global economy, businesses should be preparing for the impacts on the economics of their business. Economic forecasts much like the weather are riddled with uncertainty, with business leaders either placing gut-checking risky bets on the outlook they subscribe to or creating the agility to rapidly respond to constantly changing scenarios to optimize their advantage.
In every scenario there are tough business decisions to be made that demand deeper analysis of all available information with increased accuracy and frequency:
- Where are we most exposed to future profit pressures? – requires a thorough measurement of profitability across business lines, products, customer segments, and markets, combined with aggressive cost management to correct or protect future profit contributions
- Can we confidently plan for performance in the disparity of potential scenarios? – requires an expansion of planning scenarios and modeling methodologies that are dynamically driven from credible qualitative data and not subjective estimates
- Are we pricing from a position of power or panic? – requires informed pricing models and strategies that go beyond competitive market matching to focus on profit optimization within current resource capacity and constraints
The answers to these questions are placing information demands on Finance’s ability to shift from report production pilot to proactive analyst and generate more insights than information. Leading to a broader question for business leaders; “Is your finance team ready to answer the tough cost questions coming from the next disruption ?”.
Lack of preparedness in Finance
Over the last decade or more, the economic heat wave of revenue growth, has subdued the CFO cost control agenda. During stronger economic times of the past the focus on costs has only been indirectly addressed in relationship to revenue growth. Top line growth was the priority, overshadowing the subtle but consistent pattern of persistent cost growth that now outpaces revenue growth for many organizations. This pattern will amplify with the inflationary pressures to come, leaving Finance teams with the options of cost cutting with an ax or a scalpel. Unfortunately, there are few surgeons left in the practice of strategic cost management, and many using blunt rusty tools not suitable for this type of operation.
Finance teams are leaner than ever, continuously asked to do more with less. The function has steadily increased its efficiency, reduced headcount and spend to historically lower levels as a percent of company revenues. They have successfully automated transaction processing, generated more data and number crunching analytics, but have been slow to increase value added insights. While efficiency has greatly improved the effectiveness of the finance function continues to be questioned by business leaders. In fact, a 2019 survey by Gartner found that only 18% of business decision makers believe their management reporting data is decision ready. Worse yet, only 22% of those CFO’s believed their performance data was actionable.
This generation of business leaders have never had to look at cost control in this depth while facing excessive inflation and economic volatility. Strategic cost management is a rare core competency in today’s CFO function and protecting profits during economic uncertainty will require a new playbook to respond to the tough questions to come. The lack of talent, toolkits, and technology in Finance, casts serious doubt on their ability to produce credible insights with speed in times of crisis. The companies that will weather this storm will be those who can react the fastest with plans for a variety of dynamically changing scenarios that are informed by credible cost analytics.
Finding shelter from the storm
With the clouds rolling in on the economic recovery, and low visibility warnings in effect for future financial performance, companies need to seek shelter now to protect profits. Cost transparency is key, requiring deeper insights beyond just the expense lines of an income statement. Business leaders need to understand the who, where and why of rising cost pressures and and quickly respond with the how to effectively regain control. In the fog of economic uncertainty, costs remain the most controllable part of the profit equation. There are three levers of cost control available for business leaders to protect profits: demand management, capacity optimization, and efficiency improvement.
Managing demand is the ability to change consumption behaviors inside and outside of the organization and pricing is the key lever to affect consumption. Price increases to your customer base should start with high cost low profit intersections of customers, product and services. High volume, low customer value features of your offering are low hanging fruit where price increases or cost reductions can drop straight to the bottom line. Pricing internal chargebacks from shared services can curb the demand volumes from inside the organization as well, reducing staffing needs of non-revenue generating business units. On the supply side, having the pricing power with vendors to prioritize your demands over competitors can keep the revenue streams flowing, and help navigate prolonged supply chain challenges.
Optimizing capacity can be a tricky balancing act of variable and fixed cost infrastructures to meet current and future demands. Especially so in a volatile market where adding resource capacity can be a prolonged activity. These are tough decisions to either right size resources to meet forecasted demand, or create new demand that can leverage existing fixed costs. In either case it requires confidence in the crystal ball used to predict how consumption behaviors will change in response to future economic scenarios. Companies will want to explore new operating models that can shift fixed cost structures to more manageable variable costs through outsourcing or managed services that can flex with demand levels. Creating optimal cost synergies through merger and acquisition activity will be a highly valued component of future deals as well.
Improving efficiency is an ongoing effort in most companies, but these initiatives can be a long transformational change of technology and workforce up-skilling. In periods of cost crisis, speed and credible information matter most. Achieving the ‘do more with less’ objective can be realized by blunt force or sharp precision. Draconian measures of massive downsizing or hiring freezes rarely work and often diminish productivity, performance, and profits. In the same time it takes to do a rank and yank analysis of your workforce, a rapid cost study can identify opportunities for more precise reductions that can protect profits. Immediate targets would be exception processes, non-value added work activities, project deferrals, or exiting unprofitable product lines or markets. Over the long term, saying ‘no’ to unprofitable business practices is better than saying ‘go’ to the workforce that will drive future performance.
Tough times ahead
The ‘new normal’ for businesses may become a continuous barrage of disruptions at increased frequency and intensity. For those at the helm, they will be tested by the turbulence and struggle to find the course corrections to calmer conditions. The instrumentation to navigate the future cost challenges need to be rebuilt and the maps to profitable growth redrawn to avoid being lost in ‘the perfect storm’ of our inflationary economy.
In the fog of economic uncertainty, costs remain the most controllable part of the profit equation.
Scott Wise