May 31, 2012 12:01 am

Cost control: Cutting back to the bottom line

Mothercare©PA

Mothercare, the baby products retailer, has reduced its number of UK stores by 62 over the past 12 months

Optimistic, yet still defensive: those are the sentiments expressed by UK finance chiefs in management consultancy Deloitte’s CFO Survey for the first quarter of 2012.

In the first three months of this year, optimism among chief financial officers about the prospects for their own businesses saw its sharpest rise since the quarterly survey began in 2007 – but that has not yet translated into more expansionary strategies, such as increased capital spend, mergers and acquisitions or introduction of new products and services.

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Instead, the survey shows that British chief financial officers are even more focused on safeguarding strategies, including cost-reduction programmes, than they were a year ago. Thirty-eight per cent of 136 surveyed indicated that cutting costs is a top priority for 2012, compared with the 31 per cent in last year’s survey.

Ian Stewart, chief economist at Deloitte, is aware of the apparent anomaly of more buoyant business sentiment and still-cautious corporate strategies. “What we’re seeing is that concern over external uncertainty remains high,” he says. “The consequence of that concern is that the ‘new normal’ in terms of corporate behaviour is not to anticipate any kind of steady upturn in the near future, but instead to prepare for erratic growth for some time to come.”

For now, though, the cuts continue. For example, Mothercare, the baby products retailer, has reduced its number of UK stores by 62 over the past 12 months, and, in April, announced plans to shut a further 111 by March 2015, resulting in about 730 job losses. It is also seeking to slash its “non-store overhead costs” by £20m on an annualised basis by March 2015, with the loss of 98 jobs at its UK head office in Watford.

In the financial services sector, meanwhile, HSBC has recently announced that its three-year turnround plan is on target and that it cut costs by £2bn during the first year of this plan. In the coming months, it expects to shed 2,217 jobs from its UK workforce.

But cost-cutting should not just be a response to difficult market conditions. For some companies, it is simply the way they do business, regardless of the external environment.

“A low-cost position wins in nearly every industry,” notes a recent report from Bain, the consultants. “Cost leaders can out-invest rivals in areas such as research and development and marketing, while still maintaining attractive margins. They have the resources to capitalise faster and more readily on new opportunities. They can capture share, because they have more price flexibility.”

But many cost-reduction efforts continue to fall short of their goals, and relatively few companies succeed in making the savings they do achieve stick, the report adds. A Bain survey of almost 300 executives showed that cost-reduction initiatives launched in 2008 and 2009 in response to the downturn had reaped disappointing results. Forty per cent of respondents at companies that aimed to reduce costs by at least 10 per cent acknowledged that the target was not reached. At companies aiming for ambitious reductions of 20 per cent or more, 60 per cent of respondents admitted failure.

What can British businesses do to make their cost-reduction strategies more successful? “Ideally, cost-cutting should be a long-term strategy,” says Clive Lewis, head of enterprise at the Institute of Chartered Accountants in England and Wales.

However, he acknowledged, some companies had no choice but to cut costs to improve short-term cash flow. “Up to 5 per cent of firms are trading at a loss and more are heading that way,” he says, and cutting costs now could help them rectify the situation – but only if they make reductions in ways that will not impair the business’s ability to expand in the future. That means identifying areas where cuts will not compromise a company’s unique selling points: its specialist skills, for example, or the quality of its products.

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Many orgnisations choose to start this process by reviewing areas of discretionary spending, including marketing and training budgets. But at Briggs Equipment UK, the Staffordshire-based forklift company, chief executive Richard Close takes issue with this approach. “It is a very short-term response,” he says. “You will probably save money, certainly, but you are just avoiding the more painful decision to plan a serious restructuring that would deliver more sustainable savings.”

In 2006, Mr Close was brought in to turn the company around, and, by 2011, profits had risen to £3m, up from £300,000 in 2010. In part, that recovery has been achieved through cost-cutting, he says, and in particular, the 2010 closure of a warehouse relatively far from the company’s main premises.

“I hit an amazing wall of resistance within the company when I announced the plans to sell this second site, but that warehouse was costing us £1m a year to run and was full of unsold inventory. My logic was to get rid of the property first and then the inventory problem would solve itself. Now, turnover has increased, as has our stock turn rate and I’m saving money that I would have otherwise spent on rent and interest on stock,” he says. “It was a structural cost saving, not a tactical quick win. This is where I think cost-reduction efforts should focus.”

At Cheshire-based Oliver Valves, which manufactures valves used by companies in the oil and gas industry including Shell, BP and Exxon, chairman Michael Oliver expects cost control to be a top priority for his procurement team, just as it was for him when he started the company in his garage back in 1979.

In their negotiations with UK-based steel suppliers, they offer the companies guaranteed orders for the coming year, but on three conditions: the suppliers must keep the steel on their own site until it is needed at Oliver Valves; they must ensure that it is pre-certified for quality by independent assessors; and they must offer discounts to Oliver Valves that reflect the volumes the company orders.

The company also works with a wide pool of international suppliers. It has a procurement team in India that deals directly with local suppliers, regularly achieving 30 per cent cost savings on components compared with the prices offered by UK suppliers.

“We know to the penny what our costs are – and I mean to the penny,” says Mr Oliver. “We have a saying here that ‘gross margin is king’, so we simply don’t accept an order in the first place if it doesn’t offer us a gross margin of at least 50 per cent. If you don’t understand your costs really thoroughly, you’re not running your business well. It’s as simple as that.”

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