Can we PLEASE control cost?
Every organization tries to control cost, but most do it poorly. Competitive pressures, globalization, the lack of sunk-cost-thinking, and the pace of technological innovations have made cost control an oxymoron. Eliminating useless cost structures require accounting and financial leadership..
The Controlling of Costs
There are few topics in business studied more than that of costs. There is no paucity of research papers, accounting firms, tools, consultant advice, and theories on how best to control cost. To date, there are approximately 42,000 US accounting firms and 15 million small businesses. Each company has access to either or both internal or external accounting resources to track and report costs. Yet, cost control remains a paradox and reactionary activity. There is little evidence to support that if costs are known, then it can be controlled. This has been a management assumption, and a false one at that. Costs are generated by people, and people hate to be controlled; led yes, controlled no. Costs do not generate themselves. They are incurred with the goal of achieving an objective. We forget that all cost is sunk-cost.
Typically, businesses seek to control cost during the budgeting process and when reports indicate positive variances. However, by the time cost reports are run it is too late. Money has been spent and unfunded opportunities forgone, along with drops in profit and shrinking cashflow. These symptoms mask other types of costs problems. In drastic cases, senior management often approach cost overruns and missed revenue targets with across the board cost cutting. Cutting cost is NOT controlling costs, it’s just cutting. This is a crippling and pedestrian approach to cost reduction and control. What should be clear is that effective cost control is strategic and affects the entire company’s competitiveness. Cost control and reduction cannot be just an internal accounting function, nor can you cut your way to prosperity. Controllers and CFOs must provide the cost control leadership that engenders sustainable operations and new value creation that enhances corporate competitiveness.
Having cost information is not cost controlling; and having cost control is necessary, but not sufficient. Cost control or cutting won’t save a company, if the process is not understood or tied to markets served. Cost is the utilization of resources to achieve market objectives. Costs are incurred with the purpose of achieving customer valued objectives. Cost incurred without objectives achieved is the very definition of waste. If the market is not willing to pay for it; or is does not value a cost, then your company should not incur that cost. Effective cost supports the production of products and services, innovation, and grows the company’s markets. Costs that do not deliver the planned business objectives are ineffective and by definition waste. The lack of adequate costs measures and leadership in these areas have led businesses down a misguided path to ruin. This includes focusing on creating greater cost efficiencies. This is a mistake. The market pays for being effective, not efficient. Efficiency is doing the right thing. Effectiveness is doing the right thing correctly. Implementing effective cost control requires understanding one’s business and markets, as well as the implementation of a value creation plan.
Approaches to Cost Control
Controlling cost does not begin with budgets, variance reports, or cost analysis. Rather it begins with the understanding of the business and its markets; otherwise cost accounting becomes increasingly useless reports that create the illusion that you are monitoring relevant data and making worthwhile decisions. It does not matter whether the company is a high rate consumer manufacturer or offers business to business services. Without the use of market data cost accounting becomes just numbers at risk of only reporting costs disconnected from market realities.
Effective cost control must include understanding your markets. The markets supply revenue, profitability, and cash flow to a company. They also supply the labor, materials, and overheads used by companies to achieve business objectives. This means that they also influence a company’s operating structures. Tactically, the cost control system must reflective top-down and bottom up approaches for tracking cost behaviors and drivers that engender better decision making. Cost behaviors reflect how activities of an organization influence its costs. Cost drivers are the measure of activities that consumes resources causing costs. This is true regardless of your cost accounting approach.
There is a variety of cost accounting approaches including job base costing, standard cost accounting, resource consumption accounting, throughput, and activity based accounting that companies can use. Each has its strengths and weaknesses with regard to characterizing the elements of costs. The correct approach is the one that offers 1). best characterizations of costs, 2). facilitates better decision making, and 3). creates market value. Cost is ubiquitous throughout the company. More often than not, a company's direct cost produces a small portion of a company’s revenue. However, costs can be tied to 100% of a company’s activity. If a company's costs do not represent creating or sustaining the activity associated with competitive advantage and value creation, then it must be eliminate and resources reallocated.
Effective cost system controls facilitates better and more timely decision making. It continually improves predication making capabilities. The right cost control system inspires commitment, and not just compliance. The cost accounting reports cannot just point to what has happened, but rather inspire what needs to happen and how. If numbers can inspire people (e.g. athletes) to greater achievements, then it can do the same for employees. Strategic cost control and its innovations can be market-disruptive by shifting "the cost curve" create new value for the company and its markets. This requires the understanding of market and industry structures and trends, as well as the overheads and labor that influences costs.
Summary
A company’s revenue, profits, as well as costs parameters are dictated by its markets. No cost control system can be permanent as markets are constantly changing. Few worry about cost control when there is little competition or unbridled growth. Costs can be out of control and a company can still be profitable. However, the increasing globalization of markets and financing of growth are continuing to challenge companies to be more cost competitive. Where, how, and what costs to reduce are more than tactical discussions and decisions. They are strategic. Companies should embrace the process of cost control and reduction as strategic-value-building-opportunities.
Hiram Willis
Ph.D. Finance
