While it’s true that CFOs can’t control all of their company’s cost structure, Gartner research shows that their behavior — the way they proactively approach cost allocation and management and remove activities that drag down earnings — can have a tangible impact on shareholder returns and contribute to sustained value-creating growth.
When looking at cost management behaviors, CFOs can start from the maxim: ‘first do no harm’
“CFOs are operating in a challenging environment where costs have outpaced revenue since 2013,” said Tim Raiswell, Gartner VP Analyst, during the Gartner CFO & Finance Executive Conference in Washington, D.C. “The positive news is that CFOs have greater control of the situation than they might think, and choosing to eliminate negative cost management practices, while employing positive ones, can have a significant impact on the bottom line. This is exactly where we see the best CFOs distinguish themselves.”
Companies typically approach growth by focusing on one of three things:
- High growth: Trying to outpace the industry in revenue growth
- Low costs: Minimizing costs as much as possible
- Balanced approach: Balancing bottom- and top-line growth
Gartner research showed the average shareholder return among companies that employed a balanced approach was 7% higher than peers. But what role does the CFO play in effectively managing the cost piece of the balanced approach?
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Remove the cost-cutting mistakes that drag down earnings
It’s not uncommon for CFOs to have a knee-jerk reaction to cost management when threats such as recession loom, but Gartner research showed widespread missteps in cost management — often resulting in resources being diverted away from smart growth plays. In fact, many of the companies studied by Gartner exhibited at least one cost mistake that negatively impacted company performance.
“When looking at cost management behaviors, CFOs can start from the maxim: ‘first do no harm,’” said Raiswell. “Unfortunately our data shows that 93% of CFOs are exhibiting cost management behaviors that actually harm their businesses. Identifying and correcting these behaviors should be a first-order priority.”
The three key cost mistakes are:
- Cost equivalence: Eighty-nine percent of companies can’t differentiate between value-added and transactional costs, or fully understand which costs contribute to growth, with what frequency and predictability.
- Losing business commitment: Cost campaigns that fail to engage functional and line leaders face resistance and will be slower and less effective.
- Stifling growth investments: S&P 500 companies cut capital expenditures by 25% and R&D spend by 55% on average between the fourth quarter of 2007 and the middle of the Great Recession in 2008.
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3 habits that distinguish elite cost-cutters
“Insuring that finance initiatives don’t harm the business is a great place to start, but elite cost cutters use simple, repeatable strategies that reroute underperforming capital to the right projects,” said Raiswell. “The key differentiator we found when studying companies with the best long-term performance was a continuous effort to ensure that funding moved from losing to winning projects.”
Gartner identified three key positive cost management behaviors that directly contributed to healthy, long-term growth:
- Use a value framework to sequence and prioritize cost cuts. Not all businesses and costs are created equal. CFOs should construct a portfolio view of which businesses to prioritize for cost-cutting based on their contribution to financial strategy. Further, costs at the business level that do not have a strong statistical relationship to sales should be prioritized for cutting.
- Make cost-cutting more urgent for management by having them own the naming and quantification of earnings headwinds. Many CFOs claim to enable the business to name, quantify and tackle the headwinds that slow growth. But finance-driven operating reviews rarely end with corporate and line management consensus on what needs to be done to tackle threats to profitability. The key is to pass the burden of proof to line management to explain the economics of their business in a headwinds/tailwinds format so that they fully own the top- and bottom-line outcomes.
- Attack information gaps in growth investments to prevent uncertainty overwhelming investment decisions. When firms are pressured to reduce costs, growth investments are often among the first things on the chopping block. This can set firms back several years in the innovation game. Instead, CFOs should help deconstruct complex business cases into their most uncertain components, seed-funding the portions that will help management address the biggest uncertainties about the future performance of the investment.
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