Costs have outpaced revenue at S&P 1200 companies since 2013. The CFOs of top-performing organizations have learned to cut costs more effectively than their peers, giving their organization an edge. As potential turns in the economy loom, reactive cost-cutting mistakes can derail profitable growth.
“We generally see three main cost cutting mistakes,” says Jason Boldt, Director, Research, Gartner. “Top CFOs avoid making cuts across the board, stifling growth investment or losing the business’s commitment.”
Consider a spectrum with cost-cutting at one end and cost optimization at the other
These kinds of errors are particularly problematic late in an economic cycle because organizations tend to rush to cut costs and therefore do so in a haphazard manner, rather than a considered one.
“Consider a spectrum with cost-cutting at one end and cost optimization at the other,” says Boldt. “On the cost-cutting end, there are tactics that can quickly help shore up liquidity and meet market expectations for profitability. On the cost optimization end are long-term tactics that organizations pursue to boost efficiency and transform business operations.”
Mistake No. 1: Make across-the-board cuts
When making across-the-board cuts under pressure, organizations tend to target highly visible categories like input costs or salaries and benefits. But just because a logistics company can quickly switch to a lower-cost, lower-quality third-party provider doesn’t mean those cost outlays aren’t essential for day-to-day operations.
“Urgency can push finance leaders into a posture of ‘just cut something, anything’” says Boldt. “However, applying a value-based framework to cost-cutting decisions, positioning each business area according to its performance across various dimensions, is a quality that makes CFOs stand out from the crowd.”
Mistake No. 2: Lose business engagement
The second regular casualty of pressured cost-cutting is often proper engagement with business leaders. In many organizations, the leader of each unit will often feel they are poised to deliver the most growth or have already seen their fair share of cuts. Therefore, commitment to a program of cost-cutting or optimization is often in short supply. This is precisely the type of scenario in which engagement with business leaders is vital, and yet it’s often overlooked.
It’s difficult to properly create and apply an accurate value framework to cost-cutting without the support of business leaders. That support can be less forthcoming if business leaders can’t understand the rationale for cuts or feel unfairly treated.
One approach to generate support is to explain the rationale: Name and quantify the threats to business performance. Another method is to make the business leader more directly accountable to investors, for example, by making a public cost-cutting commitment.
Mistake No. 3: Stifle growth investment
Between 4Q07 and the middle of the Great Recession, S&P 500 capital expenditures were cut by 25%. Yet in the same time frame, investment in research and development (R&D) activities were cut by 55%. This reflects the short-term mentality that many seem to have around cost-cutting.
Top CFOs look for growth opportunities that become more attractive during a downturn in performance, such as accessing a loose labor market or acquiring discounted assets.
“One way we see CFOs keep the growth investment engine on is to use proof-of-concept financing, which is a way to reduce uncertainty around certain assumptions in an initiative,” says Boldt. “We consistently see leading CFOs make big, bold growth bets while other CFOs are reining in investment because the uncertainty is overwhelming the average company’s decision-making ability.”
Learn more: How to use cost-cutting to drive business growth