Organisations that achieved unexpected cost efficiency gains as a result of operational constraints due to the Covid-19 pandemic risk losing these gains needlessly, according to research from Gartner.
The traditional approach of reintroducing costs after a business downturn based on recovered revenue fails to account for permanent shifts in the business environment.
There have been numerous efficiencies discovered as a result of increased use of technology, changing customer preferences and a significant move towards permanent remote work.
“Some organizations are discovering there is a beneficial side to the extreme budgetary discipline and constraints they have been operating under for the past 12 months,” says Dennis Gannon, vice-president: advisory for the Gartner Finance Practice.
“Functions across the organisation have found cheaper and more efficient ways of operating through digital investments that enable remote work and customer engagement, many of which will remain permanent ways of doing business,” Gannon says. “For chief financial officers (CFOs), this means costs need to be examined differently before being reintroduced, to ensure they are still relevant in this environment.”
The most common approach to reintroducing costs after a downturn relies on matching new costs to recovered revenue in order to preserve profit margins. Reintroduced costs are pressure-tested to ensure they are in line with previously established profit margin structures, helping to ensure that new spending maintains margin in the short term.
Gartner’s research, derived from polling data of nearly 100 finance leaders, complemented by additional qualitative interviews in the summer of 2020, identified a more effective “constraint-informed approach” to reintroducing costs. This approach focuses on identifying and leveraging the cost gains made during the past year as a result of organizations reimagining how they do business.
Identifying Sustainable Cuts and Differentiated Costs
The first step for CFOs seeking to maintain cost efficiency gains is to determine which cuts made during the pandemic are truly sustainable. While many of the most severe cuts, such as factory closures and hiring freezes, could result in permanent damage to the organisation if extended indefinitely, Gartner research suggests that other risks are often overstated when executives attempt to recover costs back into their function.
“Taking a risk management approach to understand which areas of the business are under more or less stress in this environment can help CFOs better allocate resources from low-risk areas to higher-risk ones,” says Gannon. “Following this approach for sustainable cost optimization, and maintaining visibility into cost optimization initiatives, will help CFOs gain a clearer understanding of Covid-19’s long-term impact on the overall business.”
After the sustainability of cost reductions is clarified, CFOs can then better align functional spend to strategic differentiation. Gannon recommends segmenting costs into three buckets to accomplish this:
* Differentiating – Unique costs that create a point of strategic advantage and cannot be easily replicated by competitors, such as proprietary technology.
* Enabling – Costs that help achieve mission critical operational outcomes but are not necessarily differentiating or unique, such as data science talent.
* Commoditising – Costs that any competitor tends to occur and are unrelated to the organisation’s unique value proposition. Organisations often incur such costs inadvertently when responding to a competitor’s actions. Previous Gartner research has examined this category of spend and how CFOs can minimise it.
Turning Constraints into Capabilities
In order to successfully implement a constraint-informed cost management program, CFOs and other functional leaders must change their mindsets on how costs are viewed while also identifying the transformational opportunities that resulted from operating with the constraint in place.
To accomplish this, Gartner has developed a cross-functional “constraint-to-capability cascade” framework designed to identify the trends that have accelerated during Covid-19 and the go-forward implications for cost optimisation.
“The constraint-to-capability cascade framework allows for more nuanced cost decisions around legacy programs while helping CFOs and other executive leaders identify the new opportunities that deserve more funding,” says Gannon.