Why many CFOs are reaching into the cost side of the business - especially now.
- Continued economic uncertainty in 2024 will drive many businesses to more proactively control their costs as a means of achieving profit targets.
- Developing more robust cost consciousness and cost containment capabilities can help companies save considerable sums without resorting to cost cutting or layoffs that can negatively impact an organization’s ability to grow.
- The contractual long middle period between signing a multi-year contract and renewing it provides significant opportunities for cost containment for organizations that prioritize putting in the time and effort to uncover the savings.
With the new year well underway, companies are heavily factoring economic uncertainty into their strategies for hitting their 2024 numbers and meeting the promises made to their various stakeholders. The reality is, for many companies, growth is not a given this year. That means companies will reach into the cost side of their businesses to hedge against uncertainty and potentially slower or declining sales. For many organizations, proactive cost control represents new territory, especially for businesses that have historically benefited from steady sales growth or M&A.
We sat down with our newest board member, recently retired longtime CFO Michael Lewis, to gain insight into how financial leaders are dealing with uncertainty in the new year and why this may be the ideal time for growth-focused and highly acquisitive companies to turn some of their attention toward the hard work of cost management. We discussed how the best CFOs develop the full spectrum of cost optimization skills, including what Mike bucketed into three phases: cost consciousness, cost containment, and the least desired state of cost-cutting.
Read on for the details of the conversation and Mike’s insightful perspective.
Q: From a CFO’s perspective, what is the biggest concern about the current market conditions?
A: I think 2024, while it won’t be worse than 2023 for most businesses, it has the potential to be flat for many companies. The macroeconomy may not be in a technical recession, but there are still pockets of angst, driven largely by ongoing uncertainty. Right now, CFOs are getting a lot of mixed signals: layoffs are happening, but retail sales are up. Inflation looks like it’s getting tamer one month, which changes the next. Private equity exits have slowed down, and new deals aren’t as plentiful. And it’s harder to buy companies, especially if you’re funding them with debt.
In these uncertain times, CFOs simply don’t trust that growth will happen. Nevertheless, they still have EBITDA targets that they’ve either told the Street through guidance or that private equity has established for them. They’ve got to get to the numbers somehow.
Q: If growth isn’t a given, what levers can CFOs pull?
A: In times of uncertainty, CFOs who can’t trust growth have to pivot and drill deeper into the cost side of the business. For many, this is easier said than done. If you are an M&A CFO or a CFO in a sales-driven company that’s been operating in growth mode, for example, you haven’t spent a lot of cycles on P&L cost reductions because you haven’t had to. You’re too busy putting infrastructure into place. The contracts for what you’re buying sometimes go by the wayside. You’re probably thinking more about how we can spend money by adding more salespeople versus looking at the supplies or services contracts to find opportunities for savings.
But there’s value to be had within those contracts; now’s a good time to tap into it. Often, it’s not just the purchase price where you can save. There are rebates, volume discounts, and many other types of contract provisions that aren’t being actively managed and have the potential to impact the bottom line significantly.
Integration is another area to investigate, especially for companies that have recently done a lot of M&A. When you’re buying a company, you’re assuming their contracts. But companies often move on to the next deal, and they don’t always have a dedicated integration team that captures the synergies and ensures that contract terms are optimized across the board. Software as a Service (SaaS) spending is just one example of an area where M&A results in costly redundancies that often go overlooked.
Q: How do CFOs typically think about controlling their costs?
A: The approach to cost largely depends on the CFO’s orientation. For example, organizations and CFOs can be accounting-focused, M&A-focused, sales-focused, or operations-focused. Their appetite for spending and cost optimization will depend on the growth mode and momentum of the company.
Organizations and CFOs ultimately progress through three different cost management phases that look something like this:
Companies move through the different cost control phases at different rates but sometimes companies need to jump into cost cutting very quickly. Cutting people is a common reaction because it’s a way to see the savings impact quickly. It can be much harder and more time-consuming work to go through thousands of contracts and spend categories to find opportunities for savings that don’t impact the business as deeply. But in the long run, cutting these extraneous expenses is always a better approach for the business.
Q: You mentioned the “long middle” What is it and how does managing it better help companies with cost control?
A: The long middle is the period between signing a multi-year contract and renewing it—essentially the period of vendor and supplier contract compliance. Companies typically spend a tremendous amount of time on the initial negotiations with top vendors, and they prepare for the renewal. But nobody really manages the middle or follows up to ensure that vendors are honoring the terms and complying with the contract, again because they are busy growing and operating the business. They’re focusing on deal creation and not deal maintenance.
There is also a fair amount of turnover in sourcing groups that complicates the situation. Sometimes the person who orchestrated that deal may no longer be around and so no one understands the details of the contract. In most companies, there is no systematic way to identify and manage the major or most important contract terms that have been negotiated outside of the prices.
This can be a costly oversight. Companies typically find a lot of opportunities to save when they start diving in. For one thing, there are many vendors that do not proactively issue rebates or other money owed unless their clients pursue their refunds. Also, price creep is common across all types of spend areas. If no one is paying attention, prices, surcharges, and fees can and do easily escalate unchecked.
Ideally, companies need to schedule quarterly meetings with major vendors to review the spend, rebates, service levels, and other terms and ensure they get the value they negotiated. This adds a considerable amount of work and effort over the course of the long middle that’s rarely enjoyed by internal teams. But it is work that always pays off.
Q: If growth is expected to slow, how do organizations take advantage of this scenario to build their cost control muscle?
A: A company should always have some level of cost consciousness. But slower growth periods, which 2024 is likely going to be due to all the market uncertainty, is really a great time for traditionally high-growth and highly acquisitive companies to focus in these areas.
CFOs and other leaders naturally aren’t thinking much about costs when everything is going great. It’s fun to grow. It’s fun to make your numbers through growth and solid acquisitions. It’s harder to cut costs because it usually involves people. And while revenue is one line item on the P&L, there can be dozens or even hundreds of costs to consider.
But companies that can build their cost consciousness or cost containment muscle and still flex those muscles even while they are running and gunning will not only be better prepared for a downturn, but they will also have a powerful advantage; they can leverage all the time. Imagine a salesperson who is always thinking in terms of how saving a dollar is the same as selling $3 and who is conscious of how the money, they are spending is going to impact EBITDA? That’s bound to significantly impact the bottom line in both good economic times and bad.
Managing the Long Middle isn’t Fun or Sexy. So, Get Some Help and Don’t Manage it Alone.
A key takeaway from our conversation with Mike is that cost management and contract compliance, especially in the long-middle, represent resource-intensive, tedious, and generally unsexy hard work. That’s a big reason why lots of companies prefer to focus on growth and tend to leave cost control muscle underdeveloped. However, those select organizations that do both well have a clear advantage in any market conditions.
The good news is companies can outsource the cost control work and often realize better, faster results when they turn to experts with the resources, data, and processes to find and capture the savings for them. Even better, you can often reduce costs without changing vendors, operations, or service levels. And you only pay when savings are achieved. It’s a win/win for everyone. To learn more about SIB’s approach to helping organizations excel at cost control and spending smarter, give us a call. And make 2024 the year you make cost control a competitive advantage for your business.