x Abu Dhabi, UAEFriday 28 July 2017

The high cost of budget cuts

The Life: Instead of cutting expenses, companies should focus on how to create value.

How a company handles queues can affect value creation. Jeff Topping / The National
How a company handles queues can affect value creation. Jeff Topping / The National

While business is picking up in the GCC, there are rumours of budget cuts and other efforts to contain costs.

Discussions in the business clubs revolve around banks implementing initiatives leading to greater redundancies, entities slashing operating budgets by 25 per cent and the regular prudent practice of cost management.

Whether the focus is lowering the cost-to-income ratio, improving shareholder returns or simply extracting the maximum profit margin, there is an increased emphasis these days on cost leadership.

But the question we should be asking is: are we obsessed with cost reduction or value creation?

Historically, cost leadership was an attempt to get to the lowest cost of operation, which included efficiency, scale and standardisation.

Should cost leadership be about trying to capture value through cost reductions or creating improved value?

Think about this: what comes to your mind first - cost savings or value creation?

There is inherent risk in cost reduction if not done properly, as it can be a zero sum game when it comes to value creation.

As an example, many service organisations such as hotels and retailers study their check-in, check-out, point-of-sales process to minimise queue time, as guests and customers want to experience a short waiting time.

In this example, if an organisation looked only at cost cutting it may make decisions to reduce headcount. But that decision in turn increases the waiting time. While the company trimmed its cost, it sacrificed value by making customers unhappy.

So, instead of looking for a savings of X, it is better to look for a productivity gain of Y. When it comes to capturing value, efficiency is one measure, but productivity per cost measure is a much more intelligent approach.

Our brain is a good example of this - in its attempts to minimise its energy usage, it focuses on efficiency. But unfortunately, as the brain becomes more efficient it loses its optimisation when it comes to creative insights and breakthrough thinking. The most efficient, practical thinkers are not always the most creative.

In other words, organisations may successfully strip out costs in attempts to become efficient and at the same time remove future value.

Creating value comes from executing and delivering the strategy, selling to existing clients, maximising the existing asset base and extracting value from mergers and acquisitions activity beyond synergies and reducing back office costs.

In most organisations, greater value is derived from identifying ways to put to work and maximise its current operations rather than spend time looking for ways to get the waste out.

In this region, in particular, organisations have more underutilised assets (including human capital) on their books that need to be maximised than they do toxic assets that need to be eliminated.

To optimise employee productivity, organisations first need to calculate the total number of workforce hours required for desired current and future output: products produced, service provided, quality achieved, etc.

Then they need to identify workforce drivers and create a model for determining task times, frequencies and related output.

When this model is in place, it should be benchmarked against industry productivity standards to see areas for additional value creation.

Do you have a "savings" or "gaining" mindset? As the region continues to grow - it is expecting healthy GDP gains for the year - organisations are trying to shrivel their expenses, but the cost leadership activities should focus on value creation.

Dr Tommy Weir is an authority on fast-growth and emerging market leadership, adviser and author of The CEO Shift.