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The grand reset of costs in 2020

Efficiency planning for the next year needs to start now. The new normal of business will need a fresh approach and a hard look at how costs can be rebuilt, assuming constancy in the revenue model.

May 18, 2020 / 07:48 PM IST

By Sugata Sircar

This year, there will be a sharp dip in revenue in many businesses and we are getting reconciled to that. We are scurrying to slash costs so that profitability is not equally impacted. The more agile businesses will be able to achieve this better than others. As the situation has caught us by surprise, the actions being taken are often in special cost cutting measures like pay cuts, lower rates with vendors for this year and the like.

Businesses must now think about the next year. For a business which is suffering say a 20 percent drop in revenue this year, assuming average levels of gross and net margins and assuming a growth of say 7 percent next year, will need their next year’s costs to be lower than last year’s levels by about 13 percent, to even maintain the profitability of last year, ignoring the current year. In other words, to sustain the profitability we achieved in 2019-20, in 2021-22, cost levels in 2021-22 will have to be lower than 2019-20.

As mentioned, businesses are slashing costs this year by tactical measures like pay cuts which may not be possible in the next year; in fact there will be cost inflation. So, structural changes in cost are needed for it to be sustainable in the next year. Assuming of course that there is no change in the revenue model.

The Approach

The interesting way of approaching this would be to think about how to transform the organisation so that it is more effective. A strategy has to be developed and a fast action plan put in place for this. With the offer remaining the same, we need to re-think the process of production and delivery to customers.

The objectives would be to achieve effectiveness, speed and lower use of factors like space, human resources, energy and equipment. We therefore have to take a Zero Based Budgeting approach and rebuild the major costs.

The overarching enabler could be digitisation. Before getting into specifics, a word about funding. Transformation will yield some savings and reductions in usage of inputs. However, it will also need investments to enable processes and technology. Here are my suggestions on how to play this.

- Clearly identify savings in cost yielded by structural measures
Identify actions which would yield return on capital (RoC) over a period of time

- Communicate clearly to investors, underlining transformation actions and their value-add over the coming years. Investors also will have to rethink their methods for assessing management actions and businesses in the current situation

Simultaneously, this is the time for businesses to make relevant investments. The top 100 companies on Nifty show a significant portion of their liabilities to be in cash. Others may have to access fresh capital. Some areas which can be explored on priority are:

Delivery Supply Chain: Some questions that need to be asked include whether the number of delivery centres is optimised? If there is merit in moving from owned centers to third party managed centers.  The opportunities for use of digital technology in storage and shipping are well established.  They can also be availed of through third party managed centers, where recurring benefits may justify recurring costs.

Production: Significant transformation is possible in manufacturing. In-house production should be increasingly modular so that different parts can be outsourced, while retaining focus on the core systems.

Some measures which can be explored immediately include availing services rather than owning equipment. The objective is to move to a variable cost model to match benefits with costs. Arrangements with equipment manufacturers which range from pure "pay for use" models to a "sharing of benefits" model can also be worked out.

It is also worth validating if basic systems like inventory planning are working effectively. Are reorder levels appropriate? Are system outputs on production, inventory, costing are being used or are they being manually overridden? This will release unproductive resources.

Customer delivery: Digital technology can be used to attract customers to products and solutions, pick up potential targets from the web, create leads and then follow through. Virtual reality can be used to demonstrate solutions, conference with and demonstrate to customers the value creation inherent in the solution.

The "influencing" stage in the sale process in one area where a smart combination of human interface and digital technology would be most effective. If this stage is robust, subsequent negotiation efforts may be lower.

Where it was necessary to physically travel and meet customers for every interaction, it will now be possible to carry out a part of these interactions remotely. Customers too are likely to accept it. Admittedly, it will need a mindset change, on both sides, but we must leverage the lockdown experience to drive this change in mindset.

This will ensure effectiveness of marketing and sales by using digital technology as mentioned above, while slashing the time required to be spent by resources. This can generate a minimum of 20 to 30% time efficiency on the base of 2019.

Applications which provide secure collaborative platforms for sales and marketing teams to engage, track potential targets and follow through the lead generation are crucial investments in these times.

The natural progression of the above is the rise of remote servicing which uses digital technology to enable remote monitoring of equipment installed at customer locations and its remote servicing.

Internal cooking: Without touching base ERP systems, the following areas offer low-hanging opportunities to cut costs:

- Applications to ensure faster closure of books and generation of financial results, including automated schedules

- Ability to generate dashboards for critical indicators

- Cyber security

There are opportunities to explore artificial intelligence (AI)- based applications too in financial planning, risk management etc, but those can come subsequently.

Space: Over the years, as businesses grew, they took up more and more physical space. This has driven a flourishing commercial construction sector and turned some of the larger organisations into the biggest office space creators in the country.

The lockdown has forced us to pause and reconsider. We do need to engage with our colleagues physically from time to time. Does that justify holding a seat for each of us in mega offices? Can the home alternate as working space for a part of the time?

Even in normal times, we may become comfortable with work from home. The environment too gains immensely from such change. We gain time and reduce the cost of travel. Organisations do not have to invest and block so much physical space.

Actions on space can be started now. This will take six  to 12 months to make any significant impact. Organisations which already have variable cost models in terms of leased space can move faster towards efficiency.

In summary, the current year is a year of reset. We re-calibrate from here our delivery model, our internal processes and our requirement of the various resource types. Businesses who can develop a strategy and quickly implement discernible change will be ahead of others for several years. When communicated clearly, investors would value these businesses better than the rest for showing foresight and the urgency for action.

(The author is the CFO and Country Finance Partner at Schneider Electric India. Views expressed here are personal)

Moneycontrol Contributor
Moneycontrol Contributor
first published: May 18, 2020 07:46 pm