Here are five areas that nearly every business will have to focus on to survive (and even thrive) in what could be a very difficult year for many industries. The Corporate Executive Board canvassed business leaders and came up with these five issues that need immediate attention.
#1: Improve Cost Discipline: Reduce COGS and Capital Use, Not G&A Spending
Sometimes, the most effective strategies appear at first to be counterintuitive. For example, it’s natural to seek cost discipline by attacking the close-in and relatively fixed area of General and Administrative (G&A) expenses. While organizations should attack G&A to get rid of the fat, if they focus only on G&A then they risk cutting beyond the fat to “muscle and bone.” In fact, G&A cuts can actually make a company less efficient by shifting direct costs to indirect costs (e.g., automated work becomes manual). Moreover, unlike operational improvements, cuts to overhead often prove unsustainable. Most importantly, companies focused only on cutting G&A risk are missing out on the far greater cost-reduction opportunity that exists in Cost of Goods Sold (COGS).
Making cuts in COGS enables companies to achieve lasting operational efficiencies. CEB finds that not only do cost leaders focus on COGS, they actually maintain higher levels of G&A than their peers, leveraging selective G&A investments to reduce the cost of ongoing operations. This enables companies to create a far stronger long-term cost position.
Incorporate capital costs into SKU reduction efforts.After years of relentless focus on sourcing and operational efficiency, the next generation of COGS reductions will come from eliminating unprofitable products. How do you optimize the cost-benefit? The answer is to look beyond conventional approaches to measuring individual SKU profitability. Many companies fail to include the cost of capital in their calculations of SKU profitability—usually because traditional cost-accounting systems do not measure capital costs. As a result, economically unprofitable SKU’s (which earn less profit than the cost associated with funding them) are systematically retained. This phenomenon becomes increasingly important as capital costs rise due to tight credit markets. The best companies make a point of including capital costs in their assessment of SKU profitability, calculating and subtracting the marginal cost of funding from SKU profitability.
#2: Protect Growth Initiatives: Elevate, Consolidate, and Protect Innovation Funding
Name and protect explicit growth bets in the capital budget.
The complement to cutting the right costs is protecting critical growthinvestments. The current economic crisis sees companies planning forincreased costs and reduced investment dollars for 2009 by activelycutting capital expenditures across the board-—especially targetingcapital projects that can be deferred. Yet, CEB finds that the bestcompanies carefully protect their key growth bets from short-termfinancial pressures. They segment their budgets with targets for bothexplicit cost savings and growth projects. They then drive both bysacrificing those pockets of “business as usual” spending that haveless strategic value.
Incorporate concrete innovation targets into performance expectations and reporting, even amidst belt-tightening.
Herd mentality and high anxiety have public companies largely managingto short-term investor expectations. But in 2009, the best companieswill manage to the interests of long-term investors. They will committo a few concrete innovation projects and allow business owners todecide how best to achieve them. This strategy puts tough trade-offswhere they should be—in the hands of business owners—and encouragesthem to consider efficient sources of innovation that can yield higherROI. It also brings to light those executives who can best managescarce innovation resources during a period of belt tightening. CEBresearch shows that the best companies realize these goals in twoprimary ways:
- Cascade Innovation Targets into Multiple Functions
Simply put, the best companies spread the responsibility for innovationaround. In addition to cost and budget levers, companies can hittop-line innovation targets by motivating fresh thinking not justwithin R&D, but across other functions that can also contribute togrowth (e.g., Marketing, Procurement, and Information Technology). - Create Central “Growth Guardians”
Instead of dispersing oversight for emerging growth platforms, the bestcompanies will assign accountability and authority for critical,explicitly named, emerging business opportunities. These guardians willaggregate some investments to preserve big growth bets.
#3: Leverage Financial Strengths: Reenvision Your value Chain as a Capital and Pricing Chain
Foster innovations that target the shifting financial strength of customers and suppliers.
Meetingcustomers’ needs is fundamental to growing your margins in both goodtimes and bad. The best companies understand how the economic crisis isshifting customer needs and values, and are transforming theirofferings through product and service innovations to address what’smost important to their customers now. Currently, that includes helpingthem reduce costs and free up cash. Consider these ways to capturesustainable margins:
- “Bite-Size” OffersConsumers in developed countries have long paid more up front forproducts in bulk (e.g., laundry detergent), saving on unit costs overtime. In contrast, consumers in developing countries buy these productsin the single-use sizes they can afford. Benefit from the coming shiftas consumers in developed countries seek lower up-front costs, payingmore per unit to buy less at one time—even if they buy the same amountacross the year.
- Terms of Purchase Inthe airline industry after 9/11, winning suppliers found innovativeways to help their customers continue to buy from them. For example, GECapital provided liquidity to airlines by purchasing their planes andleasing them back. Look to your relative financial strengths to freecash for customers.
On the supplier side, youcan use healthy balance sheets to create win-win deal terms in returnfor better prices or guaranteed availability of critical supply. Lookfor opportunities across your value chain by bringing differentsupplier-facing functions to the table to understand how today’sfinancial conditions are impacting critical suppliers. With this fullpicture, companies can position themselves at a distinct advantage withcritical suppliers.
#4: Exploit Risk Opportunities: Embrace, Don’t Eradicate, the Right Risk Exposures
Harmonize executive risk tolerances and pursue those you are uniquely positioned to manage.
During the financial crisis, the possibilities you’re able to see andseize will be shaped by your unique risk exposure and capabilities.Perspectives on risk differ not only among companies, but betweenexecutives within an organization. Especially in times of financialuncertainty, the best companies harmonize these divergent views—not tosuppress diverse viewpoints, but to create a common decision-makingframework. For example, an executive team that aligns Sales and Financeto use its strong cash position to drop price and increase market sharecan move more decisively than an executive team where Sales and Financeare at odds.
The best companies view their partners up anddown their value chains (i.e., suppliers and customers) as part of an“extended enterprise. This holistic perspective enables them toevaluate the interconnected risks across their value chains, graspingthe complete risk picture better and faster than competitors. Forexample, companies with an extended enterprise view have the ability toidentify vendor viability and business partner risks that mightotherwise go unseen. Consequently, they’re able to determine the mosteffective methods for managing these risks either by narrowing ordiversifying partners.
Evaluate your contract portfolios with an eye toward renegotiating past (and changing future) contract terms.
What made sense a few months ago may no longer be in your bestinterest. Against the backdrop of changing financial conditions,companies need to identify and renegotiate the contractual obligationsthat they (or other parties) may not be able to meet. Examine theseagreements literally: covenants that might have been waived oroverlooked in the past may very well be enforced now. For example, theinability to raise capital or maintain certain credit ratings maytrigger debt covenants and require additional expenditures, dependingon your financial condition and outstanding credit exposure. The bestcompanies will reevaluate both recent and pending contracts to findpotential cost reduction and upside opportunities.
Robustly manage fraud risks by identifying and punishing incidents of misconduct early in the down cycle.
In bad times, the risk of bad behavior also rises. As employees andeven customers experience heightened pressure to “hit the numbers,”companies’ risk exposure increases on all fronts. In response, you mustcarefully assess fraud risk across the organization, identifyingemerging hot spots. (For example, business units that face significantjob cuts or are likely to underperform in the next 6–12 months.) It isalso likely that insider trading will rise in tandem with major shiftsin strategy, industry consolidation, and rapid leadership changes. Yourbest protection is to police your own organization more proactively—communicating the company’s position on noncompliance, implementing a“no-tolerance” policy for compliance failures, and providing employeeswith real-life examples and guidance to demonstrate your commitment tocompliance and ethics in any environment.
#5: Make Critical Talent Plays: Use Today’s Crisis to Court and Cultivate Tomorrow’s Winners
Seize the opportunity to close critical skill gaps with “not-in-play” talent. It’sonly the beginning of the buyers’ market for talent. The economiccrisis will create a once-in-a-generation opportunity to deepen yourtalent bench.
And it’s not just a matter of combingthrough the talent flooding the labor market. One of today’s primarylessons is to take your time, and be picky. Even as job losses infinancial services and other talent-centric industries are freeing uplong-scarce talent, more is sure to come. While many companies aretaking the opportunity to aggressively replace their ownunderperformers, the best companies are being more strategic. They areprioritizing critical skills first and are still focusing primarily ontalented professionals who are not actively looking for a new job. Intimes of uncertainty, great passive talent is much more likely to bereceptive to a job opportunity that offers them a more compellingposition or future. The best companies also bear in mind that thereverse is true—other employers are eyeing their top performers—andtake measures to better engage and retain their most valuable people.
Reward relative outperformance (even if you must court the wrath of executive-pay watchdogs).
When planning for 2009, companies must resist what will surely becrushing pressure to slash pay for executive high performers. Greatexecutives get paid a lot because the difference in financial resultsdelivered by “average” and “great” is enormous. The company thatunilaterally cuts executive pay will more likely get the former ratherthan the latter. That said, the best companies will rethink goldenparachutes and other window-dressing that is out of alignment withshareholder interests. The bottom line: set pay to market, but designpackages to reward outperformance.
- Managegovernance concerns by removing authority for executive compensationplan design (to the extent possible) from the senior executive team andinside directors.
- Pay for long-term shareholderinterests, over-weighting ROIC, EPS, and total shareholder returnrelative to other metrics (ROA, margins, etc.).
- Determineexecutive pay on a relative basis compared to an industry peer group,comparing not only total pay, but each component (e.g., bonus, options,long-term incentive plans).
- Avoid monkey business withoptions—evergreen options, “reloading,” and resetting strike prices.They aren’t necessary and they raise eyebrows.
- Makepay transparent—shareholders shouldn’t need to scour a proxy statementwith a magnifying glass to understand how executives are paid.
Use the economic crisis to sharpen the acumen of future executives.
All executive teams will be called upon in 2009 to make critical, insome cases “bet-the-company,” decisions. The best will find structuredways to enfranchise and develop high-potential managers by activelyengaging them in addressing issues presented by the economic crisis.The crisis-management experience that this cadre gains now will pay offfor decades.
SKU proliferation is one of the single biggest opportunities for COG improvement. Companies today lack tools and process to manage their SKU’s in a sustainable manner. Products life cycles are shorter, customers are demanding more choices and new market segments are emerging every day. In this environment, companies need a sustainable process and tools to manage SKUs based on what customers are buying.
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