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The world has changed. Your business is changing. Is your cost base keeping pace? The answer has critical competitive implications following the lifting of lockdown restrictions in England, and at a busy time for strategic M&A activity across all sectors. The evolution of cost bases is a critical factor for businesses to continue to drive value.
So why is it time to rethink costs? When people think about costs, the first priority is how to get them down. However, as crucial as this is, it’s only part of the story. As your business changes, you need to think about whether resources are being targeted where they can deliver the greatest return – ‘good costs’ – or being wasted – ‘bad costs’.
‘Good costs’ enable businesses to move closer to customers, differentiate their capabilities and develop new value propositions. Right now, this includes directing spending towards digital transformation and the transition to a low carbon economy. In firms we’ve worked with, typical examples of good costs include funding the shift from bricks and mortar sales to online engagement and next day home delivery. Other examples include stepping up investment in fast-growth ‘green’ opportunities.
Cost-based transformation (CBT) seeks to identify and optimise the good costs, while eliminating the non-essential ‘bad costs’ to free up capital for investment. The bad costs include operational inefficiencies that need to be tackled in areas such as IT, customer care and compliance. The bad costs also include low- and no-value overheads that should be eliminated altogether, from surplus office space to legacy IT systems.
Based on our experience, we find it useful to look at costs and the choices driving these, through three lenses:
One benefit of the turmoil inflicted by the pandemic is that businesses have a much better idea of what costs deliver real value. It’s important that we keep hold of the processes and techniques that reduce costs and increase productivity.
After lockdown restrictions were lifted in England on 19 July 2021 (and have begun easing in other parts of the UK), it’s both unsafe and unsustainable for businesses to go back to spending as they did before. Starting with the ‘blank sheet’ of Zero-Based Budgeting (ZBB) would help to distinguish what is immediately critical from what can be turned back on cautiously, and what can be switched off once and for all.
The starting points for this ZBB evaluation are a clear sense of how market dynamics have changed, what spending is genuinely essential as a result, and what can be reallocated. Running through ZBB is the need for end-to-end data on cost drivers and a readiness to challenge assumptions even if this demands tough decisions on legacy commitments.
While Cost Based Transformation (CBT) can benefit all businesses in this time of rapid change. It’s especially applicable for acquirers, whether they are looking to create value through scale and synergy plays or more ambitious transformational deals.
Particular sectors are likely to have different CBT priorities. For example, while a logistics business might be looking to CBT and ZBB to deliver more goods for less, the main focus for a technology company would be how to sharpen the targeting of resources for growth.
So what are the starting points for effective CBT? In our experience, five key priorities stand out:
Look at where growth and returns are strongest and make sure available funds are targeted towards these good costs.
Cost-cutting should be holistic. Rather than focusing on particular functions in isolation, it’s important to look across the organisation and challenge what the business does, how it does it and whether it is aligned with growth plans.
Target quick wins that can release cash and help to fund further efficiency savings and good cost investment.
Rather than simply tweaking existing processes or trying to deliver the same output with less input, it’s better to reduce low-value activity and challenge whether outputs can be achieved in more efficient and sustainable ways.
We work with businesses from across all sectors to help them better understand and transform their cost base. If you would like to know more, please feel free to get in touch. To find out more about the deal drivers in your sector, see our latest M&A Industry Trends.