The era of permanent cut-backs?

Jul 21 2009 by Nic Paton Print This Article

You may feel all the painful cuts and cost savings you have achieved over the past 18 months are now done and dusted, but really all most managers have done is the easy bit, according to new research.

With latest forecasts suggesting the UK economy is likely to decline this year by its biggest amount since the end of the Second World War, most companies are expecting to have make further cuts of anything up to a quarter over the next two years.

And don't expect such cost-cutting to be a one-off, either. If anything, consultancy KPMG has argued, we are entering a new era of permanent cost-cutting and financial control, an era where organisations will have to "earn the right" to grow through tight fiscal discipline and rigorous control.

KPMG has suggested companies are planning further cuts of up to 25 per cent in the next couple years, having already done the "easy bit" by trimming costs and curbing discretionary expenditure.

Its finding has come as consultancy Ernst & Young's latest ITEM Club forecast of the health of the UK economy has suggested British GDP will contract by 4.5 per cent this year, the largest decline in a single year since 1945.

While this will be followed by a subdued recovery of 0.5 per cent in 2010, Ernst & Young argued that recent hopes of recovery are now "running ahead of reality" and that the UK economy will not see any substantial improvement until world trade starts to pick up.

KPMG found most firms had been focusing on the short term as they tried to weather the economic storm, with 86 per cent expecting or hoping that their cost cutting will deliver a payback within 12 months.

But, while this may be a natural reaction to intense market pressure, KPMG has argued such cost-cutting may not in itself deliver a strategy for permanently lower levels of cost in the organisation.

Therefore one of the biggest challenge facing organisations was how to make changes to their cost base both sustainable and generate cash for future growth at the same time.

Jeremy Kay, a partner in KPMG's European Operations Strategy Group, said: "It seems that the next 24 months will see organisations stepping up their focus to deliver further cuts to the cost base to create a sustainable advantage. This requires a bolder longer term commitment to a lifestyle change, not merely a short term diet, as old habits can easily creep back in."

Slightly more than a quarter of those firms polled said they were using organisational restructuring strategies, including headcount reductions, to cut costs.

While such strategies did tend to deliver the biggest savings, they were not the most sustainable savings for the majority, Kay cautioned.

A fifth said improving process efficiency was their second most important strategy while just under a tenth claimed using better risk management was their priority in cutting costs.

"A new focus on cost management is here to stay it must become a continuum even as the economic environment improves. More than half the respondents in our survey agree that it has become a permanent and more prominent feature of day-to-day business, both now, and as and when we move out of the economic downturn," said Kay.

In fact many organisations were already taking steps to embed better cost management, such as making cost leadership an explicit part of their overall strategy.

Yet there was still work to do in broadening ownership of cost management. Just five per cent said all employees were responsible for cost management initiatives, with cost management predominantly still the domain of C-level executives.

More than four out of 10 CFOs and an additional fifth of CEOs said they were responsible for these programmes.

For the economy more widely, the UK may no longer be a trauma patient, thanks to the billions of pounds of public money pumped into the economy by the Treasury and Bank of England, but it was not out of the wood yet by any means, warned Peter Spencer, chief economic advisor to ITEM Club.

"The patient has been stabilised for now. But it remains unclear how quick and complete recovery will be and there is still a serious chance of a relapse," he said.

"Unfortunately it is hard to see any very solid grounds for sustained optimism at the moment. The only ray of hope is a potential recovery in world markets, which UK exporters can exploit because of the low level of the pound," he added.

Overall, the short-term outlook for the UK economy was still a gloomy one. This was because while credit remained constrained, the current lack of competition in the banking sector meant lending to consumers and corporates would continue to be expensive and restricted, while at the same time there was no further government stimulus available to work its way through the system.

What was likely to happen was that over time we would enter a new era where cost control becomes a much more permanent fixture on the landscape, argued Martin Scott, partner and leader of KPMG's European Operations Strategy Group.

"Many businesses probably feel as if they have done enough, in cost reduction terms, to survive the current downturn. But as only a fifth of respondents said they were looking at more radical options than they were 12 months ago, shareholder expectations to deliver bolder and more sustainable cost strategies may take some time to be met," he suggested.

"The winners will be those that create adaptive approaches to cost management so they can continually re-balance resources from underperforming areas into those that promise growth. A new era of 'earning the right to grow' is here to stay," he added.