As executives consider their 2021 strategies, they face enormous uncertainty about how the global COVID-19 pandemic, changing customer preferences and other trends will impact their business. Executives everywhere are under pressure to digitalize their business while simultaneously rightsizing their spend.
Seven major cost-reduction mistakes make it difficult, if not impossible, to manage costs strategically while pursuing growth ambitions
Gartner has identified seven major cost-reduction mistakes that executives often make — and these mistakes make it difficult, if not impossible, to manage costs strategically while pursuing growth ambitions.
A panel of analysts sat down to discuss how to avoid these mistakes. The panel included Gartner VP Team Manager Dan Garvey, Sr. Principal Analyst Samantha Ellison, Sr. Director Analyst Steve Rietberg, Managing VP Sanil Solanki, VP Analyst Ewan McIntyre and Sr. Director Analyst Piers Hudson.
This article recaps their transcribed key points, edited for concision and clarity.
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Why is cost reduction so important right now?
To understand why cost reduction is so critical right now, it’s important to look back to past economic cycles — specifically, the 2008 global financial crisis. While the 2008 crisis was rooted in different economic challenges than those around COVID-19, the differentiating factors that allowed some companies to come out of the crisis, outperforming their peers, remain true.
To pull ahead in the COVID-19 recovery and outpace the competition, business leaders need to find ways to strategically cut costs while also funding new growth investments. That means they need to consider how to reallocate resources to drive sustained cost savings and support future revenue growth so that coming out of the pandemic, their organization can sustain growth.
3 components of strategic cost optimization
Gartner calls this approach strategic cost optimization, and it consists of three components — cost-cutting, performance optimization and growth investment.
- When it comes to cost reduction, it’s important to consider whether there are areas in which to cut costs that no longer fit in the postpandemic world.
- For performance optimization, determine the current processes in the organization that are nonstandardized and burdensome. Or, given the additional investment we will see in digital technology, assess what further opportunities are provided for performance optimization.
- With investing and growing, consider how to invest in new capabilities, so when the organization emerges from this postpandemic world, it’s set up for success.
It’s nearly impossible to deliver the kind of long-term cost efficiency that an organization requires when the budget is being reduced across all areas
Read more: 10 Ways to Quickly Reduce IT Costs
Avoidable cost-reduction mistakes most leaders will make
Leaders make seven common mistakes when it comes to cost reduction. The first is making blanket cuts with unrealistic targets, but others include failing to sustain behavior change, slowing down the organization through unnecessary red tape, choking off innovation in certain areas of the business, missing the boat on digital, introducing harmful risks to the enterprise and rushing into unfair contracts with providers.
1. Making blanket cuts with unrealistic targets
2020 has been a tough year for a lot of companies. Many internal departments have been targeted for significant cuts heading into 2021, and research shows that nine out of 10 organizations have had their budgets cut in 2020. Blanket cuts across all areas make it challenging for teams to manage cost reduction in a way that doesn’t harm the enterprise. It’s nearly impossible to deliver the kind of long-term cost efficiency that an organization requires when the budget is being reduced across all areas.
Fewer than half (43%) of leaders actually achieve the level of savings they set out to in the first year of cost reduction
How do organizations end up with such unrealistic targets, and how can they avoid them? According to Gartner research, fewer than half (43%) of leaders actually achieve the level of savings they set out to in the first year of cost reduction. The reason this is happening is because unrealistic targets are being set for those cost-reduction initiatives.
Organizations need to spend more time digging into the areas of cost and how they can deliver near-term benefits back to the organization while minimizing risk, but also need to think about how those cost elements differ. They deliver different benefits across the organization, so simply slicing an arbitrary percentage of budget across the board is never going to achieve what is needed in the long term.
Read more: How to Pick Your Best Cost Initiatives
2. Failing to sustain behavior change
Given that a lot of cost-saving initiatives have a much more short-term focus, over the long term, a lot of companies that set out to achieve these cost-saving initiatives ultimately don’t meet the criteria that they’d laid out in the beginning. According to Gartner research, only 11% of companies maintain cost savings for three consecutive years. Clearly, those cost-cutting strategies, as well as the overall behavior of organizations, were focused on the short term.
If an organization wants to be continually cost-aware and promote a cost-conscious culture, then that needs to be brought to the forefront of decision making. It’s crucial for a business to understand what its individual cost structure can be.
For example, if your sales team comes up with different, more favorable payment terms, it could impact cash flow. Then, if you compound the impact it has overall at the enterprise level, that helps bring important behavior education to the forefront in an organization.
3. Slowing down the organization
Gartner research tells us that only 6% of companies consistently invest in growth opportunities without burdening the organization with excessive complexity.
Organizations place a premium on top-line growth, but one of the downsides of that is that there can often be a blind spot to the additional complexity being added into these processes when thinking about new investments. Unnecessary process steps and red tape ultimately leave organizations with too little time to talk about the right things, and more importantly, potentially mean they’re not funding future growth investments.
Only 9% of organizations create enough capacity to take on the growth opportunities they pursue
Traditionally, capital budgeting is very slow and cumbersome, even during the best of times. That can get much worse during times of crisis, particularly where growth investments are usually fast-paced — if companies don’t move quickly enough, they could lose that growth momentum. It’s important to shift the risk appetite so businesses can start to see more investments come through during these times.
Only 9% of organizations create enough capacity to take on the growth opportunities they pursue.
4. Choking off needed innovation
When thinking about reducing costs across a company, if those cost-reduction efforts are in terms of how many people are employed in an organization, bandwidth and employee confidence almost immediately become concerns when participating in or taking on some of these new growth opportunities. Only 9% of organizations create enough capacity to take on the growth opportunities they pursue.
Companies are becoming challenged to create more capacity to take on these innovation initiatives without introducing excessive costs or waste.
Think about the network within an organization when it comes to innovation. Organizations that make investments in shaking up their network and bringing teams from across the company to come up with new ideas tend to be much more fruitful than individual investments. Often, cost-reduction efforts disrupt those networks. Being deliberate about how you form and utilize those networks could become key to ensuring there’s a level of innovation and new ideas coming out.
5. Missing the boat on digital
Up until now, according to Gartner research, a lot of companies have been underspending on digital. Seventy-one percent of boards of directors say that digital technology investments are now the top business priority post-COVID, yet more than half of organizations have not yet found a starting point for digital business transformation. Money may be in the budget, but there’s not necessarily a great plan in place on how to spend it.
A majority of companies know they need to invest more in digital, but now they have the opportunity from a budgetary perspective to do that, why haven’t they started it yet?
We’ll miss the boat on digital if we don’t think of it as being a collaborative, agile and adaptive approach
One of the things to be careful of is thinking that digitalization has to emanate from and be driven by a particular function within the enterprise. We’ll miss the boat on digital if we don’t think of this as being a collaborative, agile and adaptive approach to understanding significant shifts in terms of how organizations work internally, but also in terms of how they serve their customers externally.
It’s a very complex area. It’s important to focus investments on the things that yield meaningful value based on the contributions to customer outcomes and how they mesh with all the other technology investments in the company to build something that’s truly value-adding.