Typical metrics used to prioritize cost savings initiatives do not adequately account for the timing of cash flows. Executive leaders should use these payback period benchmarks to pressure-test assumptions embedded in cost savings initiatives and their impact on their organization’s cash position.
This research has been adapted from , which helps finance leaders forecast their impact on free cash flows.
Many organizations prioritize investment projects using predefined financial measures such as hurdle rates, net present value (NPV), internal rate of return (IRR) and ROI. While NPV and IRR typically appraise cash flows over time periods up to 10 years and ROI looks at the project life span, payback periods focus on the liquidity dimension, which has become more critical over the past year. Payback periods tell us which projects “pay for themselves” over a given time frame.
Although 95% of organizations assess payback periods for traditional investments, fewer organizations use payback periods to evaluate their cost savings initiatives. This is not to say that payback periods should be overweighted; this would increase the risk of inefficient resource allocation toward short-term growth opportunities that yield lower returns. However, executive leaders should consider payback periods alongside other metrics for completeness and awareness of associated financial risk as they prioritize cost savings projects. A simple framework, as shown in Figure 1, shows how executive leaders can map payback periods against the prioritization hierarchy.
The vertical axis represents a view of where the project fits within the predetermined prioritization hierarchy. Clearly, cost savings projects with a quick payback and high priority should be continued if possible over those with a long payback and low priority. Cost savings projects in the bottom left quadrant — meeting payback criteria but low on priority — could be considered if there is sufficient funding available. The projects in the top right quadrant must be considered prime candidates for challenging scope and timelines to bring the payback down and shift them into the top left quadrant. This evaluation will help identify high-potential cost savings strategies for both near- and long-term horizons.
This research provides benchmarks that enable executive leaders to set realistic expectations for the time frame over which cost savings initiatives will actually deliver results. The payback period benchmarks cover a wide spectrum of efficiency and cost savings initiatives such as technology, people, productivity, outsourcing and centralization.
Technology-based cost savings seek to leverage technologies to improve the speed, efficiency and quality of business activities. These include approaches such as implementing organizationwide or function-specific technologies (see Table 1).
While Table 1 lists the payback periods for technology-related cost initiatives, using payback periods to evaluate technology investments is gaining momentum. In Gartner’s 2019 IoT Implementation Trends Survey, a majority of Internet of Things (IoT) implementers (86%) reported specifying a time frame for financial payback of their IoT investments, and on average, the time frame is three years. This trend is on a rise, and by 2024, 35% of organizations that invest in IoT projects will set a payback target of one year or less, up from 10% today.
People-based cost savings are often the first and most visible initiatives. These include approaches such as reducing organizationwide headcount by a flat percentage (e.g., 10%), reducing managerial span, eliminating managerial levels, and terminating low-occupancy leases and relocating the affected employees (see Table 2).
Outsourcing-based cost savings seek to leverage external providers that can perform activities more efficiently and less expensively. These include approaches such as outsourcing a defined business process to an external provider, outsourcing a step in the production process of a good or service, or eliminating a product or service (thereby forcing customers to obtain it from an alternative provider) (see Table 3).
Productivity-based cost savings seek to increase the ratio of output to input in a defined system or metric. For example, a sales productivity initiative could drive higher contract value per number of quota-bearing sales headcount. Productivity-based initiatives include approaches such as investing in a training program to increase employees’ productivity and skills and implementing an organizationwide business process standard (see Table 4).
Centralization-based cost savings seek to concentrate the people, capabilities or handoffs of business activities in a single location. These include approaches such as creating new centers of excellence (COEs), moving COEs to lower-cost locations, centralizing indirect and direct procurement activities and insourcing the production of goods and services (see Table 5).
By leveraging the criteria for projects’ financial evaluation and a better understanding of the cost savings initiatives through their payback period, executive leaders can make better cost-related decisions for the organization.
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