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Preparing for growth with cost-based transformation

How can businesses emerge from the pandemic and fund vital investment in the digital future?

As the uncertainties of the Covid-19 crisis are replaced by the prospect of recovery, businesses are turning to the question of how they can transform for growth — but for so many the question is how they can pay for that much-needed transformation.

Research from PwC suggests business leaders are keenly aware of this issue. The firm’s latest CEO Survey reveals 77 per cent of UK CEOs are planning to increase investment in digital transformation, at a time when 86 per cent are worried about economic uncertainty and 70 per cent are seeking greater operational efficiencies.

One answer to this pressing need is to undertake cost-based transformation by interrogating the cost base to find efficiencies that can fund investment.

Importantly, says PwC partner Zubin Randeria, cost-based transformation is about value creation and not to be confused with tactical cost cutting for its own sake. “There is a tendency to think that focusing on cost is a negative or defensive exercise, inevitably leading to year-on-year budget reductions and redundancies,” he says.

But cost-based transformation is a good news story: it is about how you free up resources to drive growth, with all the opportunities for job creation and new value that creates.

In sectors that have been more exposed to the pandemic, where businesses are looking at cost simply to make it through to the recovery, there is still an opportunity to drive transformation. Organisations who have realised their real estate portfolio is larger than they now need to support growth in more hybrid ways of working, may look to reduce operating costs related to property, in order to channel funding into digital transformation.

Covid-19 has affected different parts of a business in often contrasting ways. In order to fund faster growing segments, now may be the moment to spin off or wind down less profitable or productive parts of the operation. In the IT sector, the pandemic has seen growth in demand for software-as-a-service solutions, as businesses require less on-premise installations.

Similarly, the disruption of the past year has led many organisations to reconsider how teams can make better use of technology to reduce costs while increasing productivity. Embedding such productivity gains in a sustainable way will help drive transformation and cost efficiency.

Either way, the key is to be strategic. Caspar Gilroy, chairman of serial investor Broadwell Capital, warns that many companies are simply too passive about reviewing their portfolios. “Boards very rarely commission independent cost-benefit analyses of their businesses’ divisions, even though doing so might identify possibilities for using their capital in a much more productive way,” he says.

Instead, warns Randeria, the debate about cost is often tactical. He points to the example of a technology company whose CFO was urging the board to cut budgets by a set percentage across every function. “Instead, we helped the organisation define its end game — its optimal operating model, what that would cost and how to fund that,” he says. “The idea is to work out your end destination and then think about how to get there.”

That journey will not be linear. In practice, cost-based transformation comes in various forms and is executed over different time periods. However, quick wins can provide a means of funding more deep-seated change.

Most businesses will be able to find short-term efficiency savings that reduce costs relatively quickly — in areas such as procurement, for example. Operating savings may take a little longer to secure, as the organisation explores new models and channels, focusing on initiatives such as digitisation. Most ambitiously, strategic savings will flow as the enterprise focuses on areas where margins and growth prospects are most attractive.

The journey to net zero plays out in a similar way, with early breakthroughs paving the way for more substantive change. In this sense, cost-based transformation is an iterative, self-funding process. Savings secured from shorter-term efficiencies pay for changes that may take more time to implement, such as digital transformation; in turn, the savings released in this next stage of change can be reinvested in longer-term strategic priorities. “You’re working on these strands in parallel, but the more tactical initiatives pay off more quickly and help fund longer-term endeavours,” Randeria adds.

This sense of perspective is vital, says Charles Baden-Fuller, Professor of Strategy and leader of the Strategy Group at Cass Business School. “The idea that transformation comes in a single big bang is a myth. It’s a process that inevitably takes time,” he says. “As you’re going through that process, your cash flow model is changing, so the question is then how you pay for that transformation.”

Even organisations with balance sheets that are strong enough to fund investment in business model change today cannot expect an immediate return, he points out.

The reality is that your change process has to be incremental: the low-hanging fruit generates more limited returns, but it helps pay for the more expensive, long-term changes that will really deliver.

Getting the ball rolling may require an external impetus, suggests Broadwell Capital’s Gilroy. “Boards know that change is good and that it needs to happen, but they are often emotionally invested,” he warns. “I’m an advocate of taking third-party advice to help you weigh up your options.”

In time, however, cost-based transformation programmes will require executive leadership and strong governance. These are rolling initiatives with multiple goals over periods of months and years, so there is a risk of slipping off course or losing focus.

The process starts in the C-suite, with clear reporting lines and delegation of responsibility. It may take some time to identify the right levers of change and to establish a programme of execution, but setting timelines is important. Performance monitoring is crucial, as robust data collection and analysis helps to keep the process honest.

Above all, Randeria argues, the ability to establish a compelling narrative for cost-based transformation is the key to getting enterprise-wide buy-in. “You need to be able to explain why you’re doing this,” he says. “If you can’t articulate the case for change, you will find it very difficult to follow through on it.”

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